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Microcap Investing, The Ian Cassel Way
Note: This interview was published in the November 2015 issue of our premium newsletter, Value Investing Almanack . To gain instant access to more such interviews and other interesting stuff on value investing and business analysis, click here to subscribe now . Ian Cassel is the founder of MicroCapClub.com , which is an exclusive forum for experienced microcap investors focused on microcap companies (sub-$300m market cap) trading on the U.S. and Canadian markets. Ian has been investing in microcaps for 15 years and has been a full-time microcap investor since 2008. Ian looks to invest in great management teams running great businesses with a moat. He tries to invest in the best 5-6-7 companies he can find at all times. Ian founded MicroCapClub in 2011 to be a place for “real” and experienced investors in the microcap space to share ideas and learn from one another. When Ian isn’t researching stocks or administering MicroCapClub, you can find him reading, golfing, or shopping at Costco with his wife. Let’s now jump straight into the interview. Safal Niveshak (SN): Could you tell us a little about your background, how you got interested in investing and also about your wonderful blog microcabclub.com? Ian Cassel (IC): I’m 34 years old, married, and have a daughter. I live in the U.S. in Lancaster, Pennsylvania. Lancaster is a rural community mostly known for our Amish people . I am not Amish. I’m a full-time private microcap investor, which is a fancy way of saying I only invest my own capital (no family, friends, or clients) and only in small public companies called microcaps. I started investing in 1997. My parents had saved me approximately $25,000 for college. This was all I was getting, so they felt they should let me know before I started applying to Universities. At the same time, I was getting more interested in the stock market. I had met my parents’ financial advisor who was telling me about exciting technology companies. After much deliberation, I decided to go to a local less-expensive University so I could also work full time and pay for my tuition as I went. This way I could invest the full $25,000 in these exciting tech companies. I was going to get rich! In 1999, I went to Millersville University (Major: Economics), and worked full-time for a local financial advisor (I answered the phones). When the tech bubble burst in 2001, I lost 80% of my money; however, this wasn’t the biggest lesson that I learned. The financial advisor I worked for had over 1,100 clients, and when the tech bubble burst I literally heard from all them. ‘every day’ for months I would go into work, the phones would start ringing and clients would yell, scream, cry etc. I was a human punching bag. After a couple weeks I grew numb to their emotions. I also realized at that very moment I didn’t ever want to manage other people’s money. Investing is hard enough dealing with your own emotions let alone those that don’t have the mental/educational constructs. My goal was to become a full-time private investor. I just needed time to allow my capital base to snowball. In 2001-02, I started looking at smaller and smaller companies and ended up in the microcap space. I stumbled on a microcap company called XM Satellite radio in 2002. I tell the full story in detail here . Short version is I met with management, invested the little money I had left at $1.78/share, and in 14 months the stock went to $34/share. It was 99.99% luck, but my love affair with microcaps was born. From that point on, I started focusing on microcaps. Soon after, I started visiting microcap companies doing physical stock research. I felt microcaps were the best place to gain exclusive public information that could give me an edge. I graduated from Millersville University in 2003, and went right into an MBA program at Villanova University. When I wasn’t in class I was talking to management teams and other microcap investors. I learned by losing my money over and over again. I graduated from Villanova University in 2005 and started working for a firm that advised microcap companies. After six months I quit and started my own advisory firm. You can learn more about that experience here . Advising microcap management teams gave me first-hand experience on what management teams go through from an investor-capital markets perspective. I enjoyed advising, but the goal was to quit as soon as I had enough capital to be a full-time private investor. In late-2008, in the middle of the great recession, I quit advising and became a full-time private microcap investor. I now invest primarily in North American microcaps under $300 million market cap. There are approximately 11,000 microcap companies in North America, so there are plenty of rocks to turn over. Let me now talk a bit about MicroCapClub that was founded in 2011 and was formed to be an exclusive forum for experienced microcap investors to exchange ideas, collaborate on due diligence, and learn from each other. Our focus is quality over quantity in everything we do. We only have 140 members. Over the last four years, members have profiled 50+ companies that have doubled or more. Our goal is to find great companies early. Due to demand from those that don’t have the ability and/or time to apply, we are launching a subscription product offering later this year. We also recently announced the first MicroCap Leadership Summit, which will be focused on creating better investors and finding great companies early. I’m honoured to have Sanjay Bakshi, Paul Lountzis, Chris Mayer, and others speaking at our inaugural event. On our MicroCapClub Blog, myself, my partner Mike Schellinger and a few other experienced microcap investors post educational content on microcap investing. The goal with our blog is to inspire, motivate, and educate others on microcap investing. You can find me on Twitter . My mind tends to think in 140 characters. I enjoy saying more with less words and sharing my thoughts on life and investing. SN: What a wonderful story that was, Ian. Thank you so much for laying bare about yourself and your past. You are a microcap investor now. So, what’s your broad investment philosophy, and how has it evolved over the years? IC: Warren Buffett, Peter Lynch, Joel Greenblatt and many others started their careers investing in microcaps. Some of the best performing public companies ever, including: Berkshire Hathaway (NYSE: BRK.A ) (NYSE: BRK.B ), Wal-Mart (NYSE: WMT ), Amgen (NASDAQ: AMGN ), Netflix (NASDAQ: NFLX ), etc. started as small microcap companies. I’m sure you have many other examples of this in India, but the key to outsized returns is finding great companies early. If I could sum up my investment philosophy in one sentence, it would be – My goal is to own the smallest, most illiquid, least institutionally owned, best businesses I can find that are run by intelligent fanatics. I’m a long-only, quality focused, concentrated investor, investing in the best 4-5-6 companies I can find. I will hold my position as long as the management executes. I believe in deep qualitative analysis and constant maintenance due diligence so that I always know what I own. My edge is knowing my positions better than most. This gives me the conviction to hold multibaggers and the ability to see when the story changes so I can sell before the masses. The key to outsized returns is finding great companies early, when they are small companies. When you are evaluating small companies, often times they don’t have a long operating history (3 years or less). The best performing companies in North America over the last five years include companies like BioSyent ( OTCPK:BIOYF ) (170-bagger), Xpel ( OTC:XPLT ) (243-bagger), and Where Food Comes From ( OTCQB:WFCF ) (93-bagger). These companies are still microcaps today. Hindsight is 20/20 and it’s easy to think, “Yeah I would have bought these companies five years ago.” I highly doubt that. If you were to look at these three companies five years ago you wouldn’t have touched them. These companies were literally trading at a $1 million market caps with little fundamental value. Reading their financial reports gave you very little foresight into the future. They weren’t obvious. With many microcaps you have to place your bet before you have full conviction. Earlier in my investment career, I would buy a full position all at once. This works when the company works, but you can lose a lot of money if you are wrong. The biggest change in my strategy is I now prefer to buy a full position over time as my conviction grows and as management executes. My biggest winners were companies where I was constantly averaging up . SN: That’s a wonderful strategy indeed – averaging up on quality stocks as your conviction builds up. Anyways, talking about microcap investing, how are the dynamics here different from say midcap of smallcap investing? Also, what excites you and worries you most in being a microcap investor? IC: Illiquidity is a big driver of outsized returns. It just so happens that most small public companies are illiquid. The main reason for this is larger pools of capital, mainly institutions, can’t invest in small illiquid companies. Even for smaller institutions managing $10-50 million, it is problematic buying a meaningful position. Many small microcaps trade $5,000-10,000-20,000 of volume per day. In addition, taking a $500k, $1m, $2m, position in a company might not move the needle for an institution. Warren Buffett started investing in microcaps, but quickly grew out of the space and was forced to look at bigger companies. Now Buffett admits, he can really only look at the largest 200 companies in the world because it’s the only way to move the needle. The microcap space is always losing its best investors, as they have to invest in bigger companies. Larger, smarter, money can’t invest in microcaps and this creates inefficiency. Accessibility to management is what got me hooked on microcaps. You can’t access management of larger companies. Evaluating microcap management teams are important for two reasons. First, the smaller the company the more you should focus on management and qualitative analysis. CEOs of small microcap companies tend to wear a bunch of hats, so their influence is much greater than larger companies. Microcap investing is really entrepreneurial investing. So not only “can” you talk to management, but you really “need” to talk to management. I’m cautious in saying this because not every small investor should expect to be able to call up and talk to management. The point I’m making is on quarterly conferences calls, etc. take advantage of the opportunity to ask good questions. Second, when you meet with management you gain incredible insight into how the operator thinks and solves problem. I’m looking to invest for the long-term so I need to understand the long-term vision. I’m a concentrated investor in illiquid investments, so you can always find something to worry about. I don’t worry about illiquidity ; I just worry about being right. If I’m right the companies will become liquid. This is why it’s imperative you know your positions better than most. SN: That’s a wonderful insight Ian, i.e., worrying about being right. Thanks for sharing! Anyways, do you believe in the concept of ‘circle of competence’ given your focus on microcap investing where every company might look like a different industry altogether? If yes, how have you built it over the years? IC: Yes, I believe in staying within your circle of competence. From time to time I meander outside my circle of competence and the market teaches me a lesson. Investing is a lifelong education and its teacher is loss. Many of your readers remember what Tom Watson Sr., founder of IBM (NYSE: IBM ) said, “I’m no genius. I’m smart in spots – but I stay around those spots.” There are 11,000+ microcap companies that trade on the U.S./Canadian markets. I personally only look to initially invest in microcaps
Fed Up Of Rate Hike Timing? Stay Invested In REIT-Focused Funds
Comments from key Federal Reserve officials and improving economic data have added fuel to rate hike hopes. In September, hopes of a lift-off had fizzled out as the date for the FOMC meeting approached. However this time, factors that will help in deciding on the rate hike have growing in numbers. Moreover, market volatility is now at a level that should help the cause against the high levels seen in September. Investors may be ‘fed up’ of Fed’s actions or inactions and the effects of both is a story that has been done to death. But we have to remind investors about funds that would be the best buys before ‘Fed ups’ the rate for the first time in a decade, even at the cost of repeating ourselves. Fed Comments Several Fed officials pointed toward a series of rate hikes at a moderate pace. Atlanta Fed President Dennis Lockhart stated that he was “comfortable” with a rate hike “soon.” Cleveland Fed President Loretta Mester said the central bank had not firmed up on a December rate increase. However, Mester added that: “Things are on track.” Fed vice chairman Stanley Fischer mentioned that “some major central banks” could quit the near-zero interest rate policy “in the relatively near future.” New York Fed president William Dudley and St. Louis Fed president James Bullard also made similar comments. According to a Dow Jones report, William Dudley said on Friday that the central bank may approach the goals needed to hike rates, but it still has time to decide on whether or not it will hike rates in December. The timing is data-dependent and Dudley expects to see indications of increasing inflation soon enough. He mentioned that the US economy is in “good shape”, helping the Fed meet the criteria for rate hike in the near future. Separately, James Bullard reportedly said that the central bank may move back to an era of uncertain rate hikes based on meeting-by-meeting basis after the first rate hike. FOMC Minutes Minutes from the Federal Open Market Committee’s (FOMC) meeting in October stated that most officials anticipated that conditions to lift short-term interest rates “could well be met by the time of the next meeting” in December. The Fed is waiting for further improvements in labor market conditions and inflation to touch its target rate of 2% before hiking rates. Fed officials with a hawkish stance also said that further delay in raising rates will show lack of confidence in the economy. Fed officials said volatility in the financial markets has subsided since September. According to them, “the U.S. financial system appeared to have weathered the turbulence in global financial markets without any sign of systemic stress.” Moreover, officials believe that there is “solid underlying momentum” in business and consumer demand, despite a slowdown in third-quarter GDP growth. Economic Data Last week, economic data was inclined toward the positive side. The U.S. Department of Commerce reported in its “second” estimate that the economy grew at a pace of 2.1% in the third quarter, compared to earlier projected growth rate of 1.5%. Also, third quarter’s growth rate came in higher than the consensus estimate of 2% growth. An upward revision in business inventories emerged as the main reason behind the expansion in quarter. Business inventories were revised upward from $56.8 billion reported in “advance” estimate to $90.2 billion. However, third-quarter growth remained below second quarter’s rate of 3.9%. The U.S. Department of Commerce reported that new orders for manufactured durable goods rose by $6.9 billion or 3% in October to $239 billion, significantly beating the consensus estimate of a 1.6% rise. Increase in demand for large, commercial airplanes was mainly behind the gain in October. It was preceded by a 0.8% decline in September. Moreover, the Labor Department reported that jobless claims in the week ending November 21 declined by 12,000 from the previous week to 260,000. According to the Commerce Department, personal income rose $68.1 billion or 0.4% in October, in line with the consensus estimate. It was higher than September’s increase of 0.2%. These strong data added to rate hike possibility. REITs: You Can Actually Buy Them Now Interestingly, we have a contrarian view about what to do with REITs. Many would say that REITs should be offloaded and they are not very wrong given that these thrive in a low rate environment. Low rates imply low borrowing cost for the Real Estate Investment Trusts (REITs) that allow them to purchase or develop real estate. Moreover, REIT stock yields become more attractive when Treasury yields fall (REITs are often treated as bonds because of their high dividend paying nature and therefore, Treasury yields end up playing a significant role in their price movement). Rising interest rates lead to an increase in interest costs as REITs usually look for both fixed and variable rate debt financing to pay back maturing debt, and fund their acquisitions, development and redevelopment activities. Therefore, REITs cannot practically run away from the impact of rate hikes. But the extent of such an impact would depend on the nature of their leases and funding activities. As for the contrarian view, an improving economy will step up REIT activities and thus an increased demand for space. Since supply has been slow with tepid economic recovery in the past, this increase in demand would lead to higher rents and occupancy rates. Also, if rate hike is gradual, REITs will get enough time to adjust. The REIT sector investors in particular should get a boost from a stronger U.S. job market, improving consumer confidence and stable housing recovery. Adjustments with the rate environment would be comparatively easier for sectors with the advantage of pricing power like hotel, storage and apartment REITs that have shorter-term leases. Meanwhile, a NAREIT study shows that out of the 16 periods of significant interest rate rise since 1995, listed equity REIT returns were positive in 12. This implies that REITs actually gather more steam amid rising rates. Moreover, REITs have been proactive in the capital market in recent years. They have opportunistically used the low rate environment to make their finances more flexible, which is encouraging down the line for their operational efficiencies. 3 REIT Funds to Buy On that note, investing in funds focused on REITs would be a prudent move. Below we present 3 funds, which have significant exposure to REITs and carry either a Zacks Mutual Fund Rank #1 (Strong Buy) or Zacks Mutual Fund Rank #2 (Buy). Remember, the goal of the Zacks Mutual Fund Rank is to guide investors to identify potential winners and losers. Unlike most of the fund-rating systems, the Zacks Mutual Fund Rank is not just focused on past performance, but also on the likely future success of the fund. Cohen & Steers Real Estate Securities A (MUTF: CSEIX ) seeks total return. CSEIX invests a large chunk of its assets in common stocks of companies whose operations are related to the real estate domain and REITs. CSEIX is expected to invest not more than 20% of its assets in non-U.S. companies including that from emerging economies. CSEIX currently carries a Zacks Mutual Fund Rank #1. Over year-to-date and 1-year periods, CSEIX has gained 6.7% and 9.3%, respectively. The respective 3- and 5-year annualized returns are 15.4% and 13.6%. CSEIX has an annual expense ratio of 1.21%, which is lower than the category average of 1.29%. T. Rowe Price Real Estate (MUTF: TRREX ) seeks capital appreciation over the long run with growth in current income. TREEX invests a majority of its assets in companies from the real estate domain. TRREX also allocates a notable share of its assets in real estate investment trusts (REITs), including equity REITs and mortgage REITs. The fund may also invest in non-U.S. firms. TRREX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, TRREX has gained 4.7% and 7.1%, respectively. The respective 3- and 5-year annualized returns are 13.5% and 12.7%. TRREX has an annual expense ratio of 0.76%, which is lower than the category average of 1.29%. Franklin Real Estate Securities A (MUTF: FREEX ) invests most of its assets in securities of companies that qualify under federal tax law as REITs and in companies that earn at least 50% of their revenues from residential or commercial real estate activities. FREEX currently carries a Zacks Mutual Fund Rank #2. Over year-to-date and 1-year periods, FREEX has gained 2.4% and 4.6%, respectively. The respective 3- and 5-year annualized returns are 12.3% and 12.4%. FREEX has an annual expense ratio of 0.99%, which is lower than the category average of 1.29%. Original Post