Smallcap Discoveries: Weekly Update: August 29

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Subject: Smallcap Discoveries: Weekly Update: August 29 - September 2

August 29 - September 2

Market Commentary

Markets

This was the third straight down week for the markets. The DOW was down 3.0%, Nasdaq was lower by 4.2% and the TSX was lower by 3.0%. Nasdaq is lower by 11.8% from its recent August 16^th peak. We’ve very quickly gone from quite overbought to oversold if one looks at the near 50 basis point drop in the RSI index.

More hawkish words from the US Federal Reserve officials this past week helped send equity markets lower while the ADP payroll data had something for both the bulls and bears. The number of new jobs created in August came in at 315,000, above the economist forecast of 300,000. This is down sharply from the 528,000 new jobs in July and the unemployment rate increased to 3.7% as more people came off the sidelines and started looking for work. While the rate of job growth may be slowing it’s unlikely this will be enough on its own to change the Fed’s tightening stance.

Energy

Energy continues to be volatile. WTI oil dropped below $90 again this week and more interestingly is now back to levels that had the Saudis state that they may need to withdraw supply to maintain a price floor. Will we hear more of that type of talk this week?

Nymex natural gas broke below $9 closing at $8.90 and gasoline continues its decline reaching 6.5 month lows and closed the week at $2.46

As for the Baker Hughes drill rig data, we saw a drop of 5 rigs in the US but a gain of 7 in Canada. The active land rig count in North America is maintaining a very solid pace.

Commodities

Most commodities continue to show price weakness. Gold traded down to roughly $1700 before closing the week at $1722.

Copper, which many investors consider a good indicator of economic demand, has also been sliding over the past few weeks and is nearing its recent lows.

And steel seems to be following suit.

And lastly let’s take a look at lumber

It’s hard to look at these charts and not come away with the expectation of a slowing in inflationary pressures. I continue to believe that these commodities along with gasoline are forecasting a slowdown which is exactly what the Fed wants to see. Even freight shipping prices which skyrocketed last year are at new 16-month lows and down 52% from their peak.

If we start to see more weakening employment data, I think there will be many more calls for the Fed to reverse interest rate course or at the very least pause their tightening. I continue to believe that the equity markets are not properly pricing in this scenario and there is the potential for a “melt-up” in the market.

Stocks

I just finished re-reading “100 Bagger” by Chris Mayer. There’s usually at least one important take away that I get from these impactful books. From this book I can’t help but think about the need for patience when investing.

Trevor and I spend a lot of time looking for new investing ideas. I’m a firm believer that there is always a fantastic microcap investment out there, you just need to dig deep to find it. But I realize that finding that great investment is only part of the investing process, and quite frankly, I think it’s the easy part.

We are constantly bombarded with news headlines, with opinions, with new data with new investment ideas. There always seems to be a reason to sell your stock. There always seems to be another shiny object.

Of course, it’s important to own the right stocks but once you own the right stock you really get paid for holding it. The majority of the big gains come from having strong conviction and holding long term. The best investors are almost sloth like in their turnover of their great investments. You do end up kissing a lot of frogs in this business, but a few turn out to be princes/princesses. And it’s those that you have to learn how to hold on to them for dear life.

“Our favorite holding period is forever. We are just the opposite of those who hurry to sell and book profits when companies perform well but who tenaciously hang on to businesses that disappoint. Peter Lynch aptly likens such behavior to cutting the flowers and watering the weeds.” ― Warren Buffett, Berkshire Hathaway Letters to Shareholders.

I spend a lot of time trying to understand if the company is growing and executing its business plan, but I find I spend too much time worrying about short term price fluctuations. As shareholders we pay management to run the business. If the business is being run well then, our job is to stay out of the way.

I’ve traded myself out of several winning long-term investments. Trying to be cute, trying to trade a few extra dollars out of a great company. In so many cases, I would have been better off to just go away on vacation and let management do their job. “Set it and forget it.”

There does come a point where it’s time to sell a stock. I’ll save the selling reasons for another article, but I wanted to stress how important it is to patience and to have the conviction to hold a winner if you really want to win big. Everyone wants to own a 100 bagger but realize that the average 100 bagger takes 26 years to get there. Some get there much faster but at best you’re looking at 5-10 years for an outstanding grower. Xpel did it in about 6 years. How many stocks have you owned for 6 years let alone 26 years?

There are great businesses out there that will turn into multi baggers. In good times and in bad times. The great investors are out there looking for them right now. Brookfield Asset Management has $110 Billion ready to be spent acquiring publicly traded companies right now. “Public markets are not valuing businesses the way that private markets are,” CEO Anuj Ranjan said. “Today, I think private sponsors should be doing more public-to-privates.”

This is a fantastic time to be looking for the next great multi bagger. Public markets are awash in fear and bearish sentiment. There are great companies that are being ignored by the retail investor who is too scared to act. So many microcaps are being ignored by institutional money for many reasons. The next great multi bagger is out there and it’s likely priced at a bargain price. Maybe it’s already in your portfolio and all you need to do now is to wait and let management do their jobs.

Ryan Pape, CEO of Xpel Inc, went all in on the company in 2009. Since then, the stock has risen 51,000%, You read that right, 51,000%. Over that time, it was the number 1 performing stock on the S&P 1500. It wasn’t a straight line up. The stock had many drawdowns, including several of over 50%. There were plenty of reasons to sell all along the way. There were plenty of other shiny objects.

Let’s find the next one and let’s find the conviction to hold it.

Read more about Ryan Pape and Xpel here.

Canslim Contender

Richardson Electronics Ltd. (RELL – Nasdaq)

Last Closing Price: $15.79