Small Cap Ideas
In my last newsletter, I posted my talk from the 2017 Fairfax Financial Holdings Shareholder's Dinner on "Canadian Capital Compounders Today - 25 Market Beating Stocks". You can read my full talk, if you haven't already, or listen to it. And email me (firstname.lastname@example.org) if you want the raw file of all 25 Capital Compounder Stocks.
During my talk, I said that I love "finding capital compounders; those stocks in the small-cap and mid-cap space that eventually grow into large-caps, on the foundation of their exceptional wealth creating ability, fueled by expanding book value per share, earnings per share, and free cash flow per share...the challenge, though, is finding these capital compounders when they're small."
Indeed, finding exceptional small companies on the stock market can be tough. There's little written about small cap stocks in the media, and they have little-to-no analyst coverage. Plus, buying into small caps can often be perceived as risky. But as Peter Lynch said, "the person that turns over the most rocks wins the game."
Some readers asked where I get my Canadian small cap ideas. I conduct my own independent stock research. However, I do like to validate my ideas with several sources. The 5 growth investors featured in my book, Market Masters, are fantastic sources for small cap ideas. You can read Market Masters to find out more. But today I'm going to list three small cap sources (see below), and explore Gerry Wimmer's Investor File small cap ideas in more detail.
- Gerry Wimmer's Investor File
- Mawer New Canada Fund
- Pender Small Cap Opportunity Fund
Gerry Wimmer - I recently stumbled upon Gerry's site, Investor File, and was amazed with his investment track record. Since November, 2011, Gerry's Top Ideas "produced an average upside of 239% to date with no losers; no stock picks have negative returns; four (now 6) takeovers/privatizations at a premium to stock price; and paid out a combined total of $0.65 per share of dividends".
Here are Gerry's top five "high-point" share price performers over the past five years (stats recorded on January 2, 2017):
- Questor Technology Inc. (TSXV: QST) +1,215%
- WANTED Technologies Inc. (Takeover) +478%
- RDM Corporation (TSX: RC) +453%
- Intrinsyc Technologies Corp. (TSX: ITC) +246%
- Quorum Information Technologies Inc. (TSXV: QIS) +245%
1/3 of Gerry's 18 small cap picks became future takeover targets. His latest small cap pick that was taken over was RDM Corp. Gerry explains, "Investorfile blog was one of the very first documented opinion providers on the merits of investing in the shares of RDM Corporation following its turnaround. Since we first introduced this stock as a small cap value investment opportunity at a price of C$0.88, Deluxe Corp’s proposal to acquire RDM Corporation at C$5.45 values this stock at 519% higher. If you include the dividends paid to RDM shareholders during our coverage period, the total investment return rises to 708%."
Obviously, I wanted to learn more about Gerry's stock picking strategy and process, and to share my findings with you, so I called him up. Gerry explained that his background was working at a boutique investment banking firm as a research associate and then in investor relations. He put that collective knowledge to use when he started Investor File in 2011, where Gerry shares his small cap picks with subscribers. I recommend that you subscribe to Gerry's Investor File Newsletter. It's free. And it's invaluable. As a private investor, based in Toronto, Canada, Gerry is a shareholder in all of the companies that he covers...
So, what's the secret behind Gerry Wimmer's small cap stock-picking success? He shared with me these key principles (rough notes):
- Limits stock picks to micro cap / small cap universe
- Non-resource stocks only (many of Gerry's picks are in the Technology sector)
- Stocks have little-to-no institutional ownership / analyst coverage
- Companies are illiquid (not many shares are traded on the stock market)
- Creates a "hot list" and starts accumulating shares when "the time is right"
- Invests in companies "wisely"; employs a value-driven valuation system, where companies usually have a 6X or lower Enterprise Value - to - EBITDA, (EV / EBITDA)
- Current operations must be cash-flow positive or cash-flow break-even
- Percentage of cash per share makes up a significant portion of the stock’s total market capitalization (share price x outstanding shares)
- All of his picks are considered 'growth stocks'
- Companies have very little debt, and lots of cash on hand, so they're not as vulnerable to economic down-cycles
- Company financials are easy to understand, with most revenues generated in the western world
- Management doesn't generally have to raise cash as their business growth can be self-funded through operations
- Shares outstanding is usually fewer than 100 million, but he prefers companies with fewer than 50 million shares outstanding
- Companies enjoy recurring revenue from their products and / or services
- Patiently accumulates positions in companies over time, three months in most cases, as most stocks are illiquid
- Sells portions of his stake to take profit off the table after a big run-up in the market, or would sell a full position when there's fundamental business change, or when management has over-leveraged its balance sheet with debt
- Contacts company executives, and asks about: expansion plans, sales strategy, management experience, etc. Likes "boring management". Doesn't like CEOs who worry about the stock price more than the business, or when there's diverging views of the business among the executives
- He doesn't 'swing at everything'. Gerry has only invested in 18 top ideas over 6 years, averaging 2-3 picks per year
Again, you should definitely subscribe to Gerry's Investor File small cap picks. And check out his top predictions for 2017 (I'm personally most interested in Intrinsyc Technologies):
1. Caldwell Partners International (TSX: CWL - C$0.96)
Caldwell Partners International is a premier executive search firm whose focus is on the high end of the employment search market. While revenues were up marginally in fiscal 2016, Caldwell Partners profits were down as the Company weathered several challenges. That said, Caldwell Partners implemented cost reductions initiatives and the Company’s profits could rebound significantly in 2017. Of note, the Company’s insiders, CEO, CFO and Directors have reported buying the stock (on the open market) over the last several weeks. Caldwell Partners will report fiscal 2017 Q1 results next month. The Company pays a quarterly dividend with current yield of about 8.25%.
2. Questor Technology (TSX: ITC - C$0.66)
Many investment pundits are forecasting that companies who service oil industry as a group will perform well in 2017. This is due to an expected gradual increase in oil prices. Questor Technology is a leading provider of high-efficiency waste gas combustion systems used primarily by Oil & Gas companies to meet clean air emission requirements. We expect sales and, more so, rentals of Questor’s combustion systems to grow in 2017 from increased spending by its customers. Also, the Company expects the first sales of its new product technology in the waste-to-heat power market to occur in 2017.
3. Intrinsyc Technologies (TSX: ITC - C$1.87)
We said that Intrinsyc Technologies will have significant organic revenue growth in 2016, and it did. however, we think the growth will continue in 2017. Intrinsyc shares in the commercial success of its customers by earning recurring revenues from computer modules sales and/or design royalties in correlation with the production ramp-up of new high-tech products. We expect several of Intrinsyc’s customers will be launching commercial production in 2017. Intrinsyc Technologies is a product development company in the high technology space.
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I hope you enjoyed this newsletter. If you want to chat, email me at email@example.com. As always, happy investing.
Robin Speziale is the National Bestselling author of Market Masters: Interviews with Canada's Top Investors. He lives in Toronto, Canada. Get a copy of his latest book. Click Here.
[Robin Speziale is not a registered advisor. This newsletter does not contain financial advice or stock recommendations. Please conduct your own research and consult a professional.]