I started investing in microcaps in 2014. At that time, we were in the middle of a long bull market, and it felt like I had discovered a gold mine; an asset class that has historically delivered superior returns over the long term and where a savvy retail investor can exploit lots of inefficiencies.
I immediately dived into it, buying a few stocks that were recommended to me by a friend. Luckily, this friend was none other than Philippe Bergeron-Bélanger, who has been my mentor and business partner for several years after that.
I then read a few microcap online message boards and devoured all the information I could get my hands on. At the same time, my first stocks were already starting to generate staggering returns. I was completely hooked!
I immediately started saving more and more money and reinvesting as much as I could in my microcap portfolio. I didn’t have a clear investment process at the time, so I was mostly going with my intuition. It scares me a little to think about it today. But hey, I had to learn.
Then came a severe correction in the microcap sector in the summer of 2015. Suddenly, within a few months, my portfolio had shrunk by over 30%. On an initial investment of about a hundred thousand dollars, losing $30,000 hurts. Especially when you realize that you had no idea what you were doing and the risks you were taking.
This experience had a profound impact on my investing style. It helped me understand several mistakes that I had made (I did make many more afterward) and how to assess risks better.
Here are some lessons learned during my investing journey. I hope I can save you some painful experiences too!
Mistake #1: Investing In A Company You Don’t Properly Understand
The stock market is a zero-sum game. The outperformance of one investor comes at the expense of another’s underperformance. To generate superior returns, you need to be able to make better-than-average decisions.
The good news is that the microcap investor pool is primarily made up of retail investors, and few investment professionals are active in the space. It’s easier to become the best analyst on a company when you are one of only a handful who actually analyzes it.
However, you need to do your homework. You won’t make above-average buy, sell, or hold decisions if you don’t fully understand what you invest in.
To invest in what you understand, it’s essential to recognize your circle of competence. It’s dynamic and will improve according to your curiosity and desire to learn new things. You should also be able to determine what is out of bounds.
For me, investing in natural resources (mining, oil & gas) and biotechnologies, among others, are off-limits. I just don’t know how to understand these types of businesses well.
Mistake #2: Investing In A Poorly Managed Company
Life is too short to waste your time (and your precious capital) alongside a bad management team. Everyone will have their own idea of a poorly managed business since it’s very subjective. Personally, I don’t invest with a management team that:
- Talks more about the stock price than the fundamental performance of the company
- Has a history of value destruction (bad acquisitions, inadequate financing structures, excessive dilution, etc.)
- Is dishonest or has a questionable past
- Tries to gain personal benefits to the detriment of other shareholders
Even if the company’s product or service is excellent, that’s a pass for me. There are just too many ways for a bad management team to ruin a great business.
Mistake #3: Investing In A Company That Has Very Few Competitive Advantages
Investing in commodity businesses is probably the mistake I have made the most often during my investing career. Here, I am talking about companies that sell products or services with little differentiation in very competitive markets.
Natural resources are an excellent example of this type of commodity. An ounce of gold is an ounce of gold, and the market dictates the price. It’s challenging for a gold producer to develop strong competitive advantages or differentiate its product from other gold producers.
Outside of natural resources, there are plenty of companies and industries where few competitive advantages exist. When barriers to entry are low, competition is fierce, and it’s easy for a customer to switch suppliers, companies find themselves in a race to sell at the lowest price possible. These are generally industries where gross margins are low, and profitability is difficult to maintain regularly.
I’ve often made the mistake of thinking that a great management team can create a lot of value even in a commodity industry. I’m not saying it’s impossible, but the odds are low, and it’s a situation I now try to avoid.
Mistake #4: Holding A Stock When Your Investment Thesis Is Broken
If you’ve done your research well and taken a position in a company, you usually have a good idea of what needs to happen for your investment thesis to work out. It would be best if you also had a good idea of the potential risks.
After some time, when you realize that the company is not executing its business plan as you expected or that some risks have materialized, you need to come to the obvious conclusion: your initial investment thesis is broken.
What is difficult in such a situation is that the stock has probably already gone down, and you are sitting on a paper loss. It’s okay not to want to sell at a loss, but it’s not rational. Don’t start to rationalize that you should hold the position because the valuation is less expensive or that you could wait to come back even before selling. Move on and reinvest your capital in a company with better prospects.
And you know what the ultimate sin is? Buying more stock in an underperforming company in the hope of making back your losses faster.
Mistake #5: Investing Based Only On An Appealing Story Or Forecast
I’ve rarely seen a forecast I didn’t like. Companies are often too optimistic when they put their future outlook on paper to present to investors. Unfortunately, these forecasts are rarely achieved 100% or on time in my experience.
So I don’t invest in a company solely based on a great story or after management has told me about an extraordinary potential.
Instead, I rely on the business’s current fundamentals (revenue, profits, good balance sheet, etc.) and the history of management’s execution over the years. If I’m comfortable with the valuation based on current fundamentals, I know my risk is limited. Then I’m open to considering the bright prospects.
Mistake #6: Buy And Hold
In microcaps, I think buying and holding blindly for the long term is a mistake. Microcaps are immature, less diversified (by revenue sources, geographies, etc.), and generally more risky companies than large caps. You have to follow them closely.
When I invest in a company, my goal is typically to own it for the long term … as long as the execution meets my expectations. I have to make sure that my investment thesis holds up constantly. If it’s no longer the case, but I don’t realize it because I am not monitoring my investments closely, I will react far too late, and it will probably be costly.
Portfolio monitoring is also why I prefer to run a concentrated portfolio strategy of about 25 stocks. Beyond this number, I think it gets challenging for one person to follow all portfolio companies properly.
Mistake #7: Investing Based On Someone Else’s Recommendation
As I mentioned in the introduction, I invested based on a friend’s recommendations when I started out. I didn’t get into trouble initially until I started following recommendations from people on message boards and other investors in my network.
In 2015, my portfolio consisted mostly of companies I didn’t know enough about since I had based my decisions on several other people’s recommendations. When the market correction happened, what was I supposed to do? Buy, sell, hold? I had no idea.
Now, I still pay attention to other people’s recommendations, but it never replaces my own research. I form an independent opinion about each stock I own and why I own it.
Mistake #8: Hoping To Make A Quick Buck
”The stock market is a device for transferring money from the impatient to the patient.”
– Warren Buffett
If you hope to make a quick buck, you will probably make several of the mistakes mentioned in this article during your journey. Among other things, you will be inclined to invest in a company that you don’t understand well, which has been recommended to you by someone else, and that is managed by a team of short-term thinkers who tell you good stories but don’t deliver results.
In the end, you will try to take shortcuts; to earn money without doing the necessary work. Unfortunately, money doesn’t fall from the sky.
Instead, be patient, do your research well, and invest in a handful of quality stocks to hold them for the long term (as long as they execute).
Personally, this is the philosophy I have developed to improve my returns over seven years of making mistakes and learning from them.