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Should You Invest In Microcap Stocks

Summary Investing in microcap stocks can be very lucrative. If you have the dedication and time to put into research, microcap investing may be for you. History has shown that a microcap investing strategy can outperform major indices. Why Do I Invest in Microcaps? When I first started investing, I was a full time college student also working full time in a meat department (> 40/week). Not only was I going to school full time and working full time, but I was engaged to my soon to be wife, running a few small business ventures, and reading voraciously (mainly books on finance/economics). Balancing all of these activities while having a social life really was not that easy. So when I started to get into investing, I really was not doing very heavy due diligence. The due diligence that I performed on a company mainly consisted of reading one year’s worth of 10-Ks and 10-Qs, looking/reading other investment research on a chosen stock, and maybe, just maybe writing a quick thesis on why I wanted to invest in that company. Compared to what I do now, my due diligence was pitiful. Since I did not have the time and energy to dig into a company, I pretty much bought into popular companies that everyone else on Wall Street was buying (Apple (NASDAQ: AAPL ), Waste Management (NYSE: WM ), National Oilwell Varco (NYSE: NOV ), Nordstrom (NYSE: JWN ), and Tempur Sealy International (NYSE: TPX )). I made okay returns and the dividends were nice, but the returns that I did make were not exceptional. As time passed, I ended up graduating from college, and getting married. I soon had a lot more time to research companies. I ended up buying a company called Independent Bank (NASDAQ: IBCP ), and within a few months, made > 50% return. That is when I started to realize the potential unfollowed microcap stocks had over large cap stocks. Check out what has happened to IBCP in the past three years. I do not work in a meat department anymore, I am not going to college, and I am not planning a wedding. What I do now is research and write about investing ideas full time. Since I now have the time to dig into companies that others tend to overlook, the microcap world of investing is perfect for me. I have always been the kind of person who does things the majority of individuals do not do (the white sheep/rebel). Investing in overlooked companies that the masses are not piling into is perfect for me. Note: Readers should know that I do not limit myself strictly to microcap stocks. If I see value in a large cap stock, I am not hesitant to take a position, if I see value and opportunity. In fact, a percentage of my portfolio is in a few large cap names (NOV, Ensco PLC (NYSE: ESV ) and Chicago Bridge & Iron (NYSE: CBI )). They are not huge positions and only make up a small percentage of my overall portfolio. As time passes there will be less of a dedication to my portfolio to names like these and more of a dedication to microcap stocks. I would not be surprised to see 100% of my portfolio dedicated to stocks with a sub $50mm market cap in the near future. The Types of Microcaps I Buy There are basically three different microcaps stocks that I buy for my portfolio. The first type, which to me is very interesting and really shows that the stock market is not efficient is the world of NCAV stocks. NCAV stocks are companies that are trading for less than their net current asset value. These stocks are very badly punished companies that look like they are pretty much headed for a bankruptcy. Despite the poor past performance of these companies, they have a proven statistical history of outperforming > 28% average return/year. If you are going to buy a NCAV stock, you must be an active investor. These companies are not buy and hold companies. You buy these companies to get one last puff on that cigar. You can make very good money buying and selling NCAV stocks, but you must be an active investor. Most investors do not like buying broken businesses, so NCAV investing is not for them. Overall, if you want to beat the market, buying and selling NCAV stocks, gives you a very good chance of making the former happen. Note: When Warren Buffett was young, buying and selling NCAV stocks is how he made tons of money. He has said that the years in which he was buying these kinds of companies were his best years ever as an investor. Another kind of microcap stock that I buy are low EV/EBITDA companies. It has been said that the EV/EBITDA ratio could be the single best ratio around. In the past 20 years , low EV/EBITDA stocks have returned 2,227%, which has destroyed the returns of the S&P 500. Now if you incorporate low EV/EBITDA ratios with microcap stocks, you can make a significant return. It has been proven that the smaller the company the better long-term results. Check out the picture below that goes to prove the former. I believe that incorporating the low EV/EBITDA ratio into a microcap strategy can be very rewarding in the long run. The final microcap investing strategy, that I have just started to incorporate in my research is a microcap stock that is growing at a very fast rate > 20%/year. If you can find a microcap stock that is growing at a double-digit rate, staying profitable, and has a very bright future, you may have the potential to invest in a multi-bagger. Take a look at a company called Zagg Inc. (NASDAQ: ZAGG ). Back in the day, you could have bought this company for 20% and are expected to continue. This company would be a great long-term holding at the right price. Command Center (OTCQB: CCNI ) Market Cap 39.05 M Cash 5.15 M Shares Outstanding 65.62 M Debt 1.24 M Revenues 93.50 M Insider Ownership 26.30% EBITDA 5.87 M FCF 7.5 M CCNI has gotten hammered lately since the company is indirectly tied to the energy industry. Despite the stock falling, the company has been able to grow its revenues, and it still remains profitable. Management is currently buying back shares and has plans to continue as well. I really like how this company is FCF positive and the simple business model of this company. CCNI’s EV/EBITDA is 5.26 and is significantly undervalued on a comp basis. These are just a few microcap stocks that I am currently following. As of right now, I hold SPRS and I am planning on taking a position in IWRGF as time permits me to do so. There are a ton of other microcap stocks that I watch and write on as well. I would really love to know what kind of microcap stocks you invest in or are watching. Message me if you have an idea. If it looks intriguing I may do research for you. Should you Invest in Microcaps? Microcap stocks are not for everyone. If you do not have time to dedicate to studying microcap investments, I would suggest not to invest in microcap stocks. I believe that you must be an active investor willing to dedicate tons of time to microcap stocks if you are interested in investing in them. Thus, investing in microcap stocks is not a passive pastime like buying ETFs or mutual funds. But if you are an active investor who loves to do in-depth research, microcap investing may be for you. I have provided a few Seeking Alpha authors below who are great microcap writers. If you are interested in microcaps, I suggest that you follow them. Good luck everybody and happy microcap investing. Editor’s Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks. Disclosure: I am/we are long NOV, SPRS, ESV, CBI. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

3 Looks At Current Market Multiples

Summary The S&P 500 has come of its all-time high, down 9% from its May peak. This article puts the current level in historical context by examining three different earnings multiples. Trailing 1-year earnings, estimated forward 1-year earnings, and a measure of cyclically-adjusted price/earnings are used to frame the current market level. I leave readers with three takeaways on my views of this data. When the S&P 500 (NYSEARCA: SPY ) was hitting new all-time highs in early 2015, I authored an article entitled ” A View From the Top: 3 Looks at Market Multiples “. Given the recent market pullback, this article reprises these different views to put the market drawdown in context. This article looks at the current price level of the index via three different measures: 1) a historical examination of the index relative to trailing one-year earnings; 2) a historical examination of the index relative to forward one-year earnings; and, 3) a historical examination of the cyclically adjusted price earnings multiple. (Source: Standard and Poor’s; Bloomberg) The graph above shows the most commonly cited earnings multiple, the Price/Earnings (P/E) ratio, which shows the index level relative to trailing one-year earnings. When I wrote a version of this article in February, the market was valued at roughly eleven percent more than its average since the broad market gauge went to its current five-hundred constituent form in 1957. With the recent pullback, we are trading at just a 1.6% premium to the market’s historical multiple. (Source: Standard and Poor’s; Bloomberg) The second graph shows the current index level relative to a best estimate of forward earnings from Bloomberg. Based on the current expectation of continued strong growth in earnings, the index is valued at 16.2x forward earnings. In February, this valuation was 6.5% greater than the trailing 25-year average, which is the extent of the ratio history available on Bloomberg. Today, the market is actually trading at a small discount of 2.7% relative to this historical valuation multiple. (click to enlarge) (Source: Robert Shiller ) While we often talk about valuation relative to trailing or forward one-year earnings, as we did in the previous two sections, examining the index level relative to earnings over a length of time more consistent with an entire business cycle can be viewed as more appropriate. Above is a version of Yale economics professor and Nobel laureate Robert Shiller’s cyclically adjusted price-to-earnings ratio (CAPE or Shiller P/E), a valuation measure applied to the equity market that divides the price level of the index by the average of ten years of earnings, adjusted for inflation. With the index multiple now roughly equivalent to the post-crisis market peak in 2007, and trailing only the historic bubbles in 1929 and 2000, the CAPE is the most oft-cited reason for lowered forward return expectations in the domestic equity market. The current multiple is 46% above its trailing 144-year average. Three takeaways: When I wrote a version of this article in early 2015, the valuations looked stretched by all three measures. In my article, ” 10 Themes Shaping Markets in 2015 “, I wrote: “Stretched equity multiples domestically will necessitate that valuations be driven by changes in earnings, tempering further price gains”. Well, we have not received price gains, with the S&P 500 producing a -6.7% return in 2015. This reduction in the index level has outpaced lower earnings from the commodity-sensitive sectors of the market, making the current market valuation appear more fair. Low interest rates have contributed to higher market multiples. In the CAPE graph above, notice that the market multiple moves inversely to the long-term interest rate level. With interest rates in the U.S. again rallying with increased macro volatility, market multiples have expanded. I covered this relationship in the 2012 article, ” Equity Multiples and Interest Rates: Is the Current Risk Premium Sufficient? ” Common stock valuation techniques include discounting future earnings back to the present, which demonstrates why lower (higher) interest rates would be consistent with a higher (lower) equity multiples. Low interest rates and near-zero short-term interest rates have pushed investors from cash and fixed income into more risky asset classes, which has also driven equity multiples higher. As rates began selling off in the taper tantrum in mid-2013, it felt like rate-driven equity gains could be peaking. With long Treasuries again rallying, and the Fed signaling to the market that they are likely to move slowly even if they move the Fed Funds rate higher, perhaps this upward pressure on valuations could stick around. 16.5 still looks to be a magic number. In all three of these valuation measures, which feature different perspectives and time horizons, the average market multiple has been around 16.5x (16.19x forward earnings multiple; 16.63x CAPE; 16.96x trailing earnings multiple). Over extended time horizons, elevated earnings multiples above 16.5x are going to be consistent with below-average forward returns. Conclusion In February, these three multiples signaled that the market was rich. After our first correction in several years, the valuations now appear more fair, although the CAPE multiple is still historically elevated. Shortening the lookback period in the CAPE multiple from ten years to five years strips out the 2008-2009 downturn, and the multiple is just 28% above its historical average. Readers must ascertain whether they believe that a proper risk premium is being reflected in this market valuation, and where they believe earnings growth is headed in the context of their own risk tolerance and portfolio construction. Disclosure: I am/we are long SPY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Back To Cash, Back To Basics: Buying Stocks For A Discount

Our Portfolios are over 75% cash as we simply don’t trust these markets. We’re looking forward to going shopping but shopping wisely. That means reviewing some of our basic option strategies – techniques that makes us money. We took the money and ran – now what? As you can see, our Long-Term Portfolio is now swimming with cash as we cashed in our winners and kept the losers. Our losing positions include 24 short put sales that currently represent about $150,000 of that “Negative Market Value,” though it’s not really negative because we already have the Cash on Hand (a great benefit of selling puts), so it’s just a matter of how much cash we need to give back in the end. When we sell a put, we are promising to buy a stock for a certain price (the strike) and we get paid by the holder of the stock to make that promise. They benefit by putting a price floor under their stock and we benefit from getting cash in our pockets and, ultimately, from potentially buying a stock cheaply. Unfortunately, most people are traders, not actual investors, and they tend to forget why they entered a short put trade in the first place. Because of that, when the short put positions turn negative in a market downturn, they tend to start thinking of them as losses, rather than progress made towards buying the stock at our discount target. (click to enlarge) In the 2013 example, the stock that is used is AT&T (NYSE: T ) and the strategy was to sell the Jan 2015 $30 put contracts for $2. This obligated us to buy the stock for $30 in exchange for $2 paid to us by the stockholder. Had it been assigned to us, our net entry would have been $28 (as we had the $2 in our pocket) and, as you can see, $28.90 was the 2014 low and it hit Jan 2015 well above $30. So, in effect, we would have kept the $2 and not owned the stock and we could have then turned around and sold the Jan 2016 $30 puts for $2 and already we can sell the Jan 2017 $30 puts for $2.75 (higher premiums due to market volatility) or the 2017 $28 puts for good old $2. Either way, the concept is we don’t have to own T at all (no cash out of pocket) yet we collect $2 a year, which is more than the $1.88 annual dividend we’d be buying the stock for. If T ever does get a major selloff, we certainly don’t mind owning it cheaply and, since we’ve already collected $6 for not owning the stock, our net entry would be $24 – $8.50 (26%) below the current price. That’s our ” worst case ” – and then we can turn around and sell calls against the stock, promising to sell the stock to someone else at a pre-determined strike. If, for example, we were assigned T at $30 tomorrow, we could turn right around and sell the 2017 $30 calls for $3.50. That would drop our net basis to $24-$3.50 = $20.50 and, if the stock were finally called away at $30, our final profit would be $9.50 (46%) plus 6 dividend payments of 0.47 = $2.82 for a total profit of $12.32 on the $20.50 cash we ultimately put to work (60%). And that is how easily we slide into our 7 Steps to Consistently Making 20-40% Annual Returns: In a video from 2013 and you’ll notice the example was Transocean (NYSE: RIG ), which was trading at $44.13 when the trade was initiated on May 5th of 2012 and is now trading at $13.45 – a total disaster – or was it? As noted in the video, we sold call contracts for $1.60 per month consistently against it, collecting $9.67 before being called away with an additional gain at the $46 strike. In fact, this strategy forces us to cash out when a stock jumps up on us and, as you can see from this chart, that made for the perfect exit in the fall of 2014 at the $46 price mentioned in the video. Once called away, we don’t jump right back in and buy the stock again, because the fact that we wait patiently for a stock to be low in the channel and then sell those puts to give ourselves a 15-20% discount on the next entry and then go back to our call-selling strategy give us a huge edge on passive investors. We combine that with our basic strategies for establishing new positions – especially the practice of scaling in to new positions . We do, in fact, have 50 RIG 2017 $13/20 bull call spreads in our Long-Term Portfolio and it is our intent to sell puts, like the 2017 $13 puts for $4.50, which would drop our net entry to $8.50, which we feel is a good enough value on the stock to commit to owning 2,500 shares (25 contracts at $11,250). This more than pays for the spread so we make a profit on every penny the stock is over $13 times 5,000 shares we control and our worst case is we’ll own 2,500 shares of RIG for the long-term. (click to enlarge) Another great, live example of a put-selling strategy is Sotheby’s (NYSE: BID ), which is in our Options Opportunites Portfolio . Our cur rent position is 20 long Jan $34 calls, which we bought for $4 and are now $2.70 as BID has gone down further than we thought but now it’s very attractive to sell some puts to offset the cost of those calls. With the stock at $34.09, the 2017 $30 puts can be sold for $3.50, which is a net entry of $26.50, a nice 22% discount off the already low price. Selling just 10 of those reduces the basis on our 20 long calls by $1.75 each and now we own those long Jan $34 calls for net $2.25 and we expect Sotheby’s to be back in the $40s after their next earnings report (11/11) – plenty of time for us to cash out with a nice profit! It’s a very choppy market and we’ve gone mainly to cash but that doesn’t mean we won’t be agreeing to take other people’s money in exchange for our promise to buy their stock if it gets 20% cheaper than it is now. As the great Warren Buffett like to say: ” Be fearful when others are greedy and greedy when others are fearful .” Our strategy of selling puts to initiate positions sets us up to be buyers when others are panicking and then, once we own the stock, our strategy of selling calls sets us up to be sellers when others are in a buying frenzy. That’s why it works so consistently! Disclosure: I am/we are long BID, RIG, T. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Positions as indicated but subject to RAPIDLY change (currently mainly cash and an otherwise bearish mix of long and short positions – see previous posts for other trade ideas). Positions mentioned here have been previously discussed at www.Philstockworld.com – a Membership site teaching winning stock, options & futures trading, portfolio management skills and income-producing strategies to investors like you.