Welcome 2024 We’ve come to the end of another year. Goodbye 2023, hello 2024. I want to wish everyone a happy, prosperous, and healthy new year. 2023 was a year of growth for SmallCap Discoveries. We welcomed a number of new members; we launched a number of new features, and we even reinstituted the annual SmallCap Discoveries investors conference. It was so wonderful to see so many of our members in person again and some of you for the first time. We hope to see many more of you this year. We really do have some amazing members in the SCD community. I want to thank everyone who has made SmallCap Discoveries the wonderful community it has turned into. Trevor and I are blessed to be able to continue to do something we love and to do it with a great group of people such as yourselves. Let’s look forward and make 2024 a great year of new ideas, new opportunities, and more new friends. Looking Back Before we look forward, let's take a look back at 2023. What went wrong, what went right and what did we learn that can help us in our ongoing investing journey. 2023 was an exceptional year as far as major market index returns but if you listened to many economists and market commentators at the start of the year there were many reasons to be bearish. Inflation was creeping up, interest rates were rising, the war in Ukraine continued. There were plenty of reasons to stay out of stocks. Certainly, it seemed like there were very few reasons to own stocks, let alone microcaps. The one problem was that so many stocks, particularly smaller stocks and especially profitable microcaps, were trading at extremely cheap valuations. If you recall, around this time last year we were pounding the table and suggesting that the buying opportunities in our favourite kind of microcaps and nanocaps were about as good as we had ever seen. Yes, liquidity was very low, yes microcaps in general looked very out of favour, yes, institutional money was running away from the sector but that was the opportunity. Microcaps were extremely cheap! 2023, especially the last few months of the year, was a great year for microcaps. But you had to be a certain kind of microcap stock. 2023 was a tale of 3 markets. There was the magnificent 7 stocks, profitable and growing smaller stocks, and then pretty well everything else. If you owned the first 2 you likely did quite well. In microcap and nanocap land, generally, the market was terrible. I’ve stopped asking industry players how their year was. Most will tell you it was brutal. And that is because most of them owned stocks that didn’t fall into the first 2 categories above. If they were in microcap land they mostly owned the popular crowd chased companies. Companies that likely recently went public and are too early in their growth phase. If you owned a company that was money losing and needed to raise money you likely did very poorly last year. But if you owned these quiet, small, profitable and growing companies that were too small or illiquid for the usual mutual fund manager, you made out like a bandit in 2023. That’s exactly how it played out in my own portfolio. I had only one stock out of my ten largest positions last year that was down for the year, and surprise, surprise, it was the only one of the ten that wasn’t generating positive income. We were extremely bullish at the start of the year and it paid off handsomely. We also saw some trends start to play out that we think have long timelines. Onshoring became a theme that we called early and we believe has years to play out. This likely continues to positively impact the “boring is beautiful” theme that we’ve talked about so much. Old school, blue collar type industries that have been discarded by many investors, who prefer chasing trendy or newer sectors that have yet to prove themselves or that trade at sky scraping valuations. We were happy to own “double digit growers trading at single digit valuations” regardless of the industry. Energy was a big theme early in the year and we did play a little bit in the space but for the most part sold our few energy related stocks by mid year. I’d call that luck rather than brains as energy turned out to be impossible to properly predict as even the best in the energy business had a hard time knowing what direction energy prices would go. Energy turned out to be one of the weakest sectors in 2023. Who predicted that this time last year? 2023 was also a year that saw a handful of microcap takeovers. With microcaps trading so cheap it didn’t surprise us to see some of these companies get taken over at some pretty healthy premiums. Companies usually see a n increase in takeover actively at the extremes in market cycles. You see it near tops in markets because capital is plentiful and cheap, or you see it at market bottoms when valuations are low. Capital was not exactly cheap last year…. | | Almost exactly one year ago today we launched our first takeover list report. We highlighted 9 stocks that we felt had a high chance of being taken over or taken private. It turned out we got only one right but that didn’t stop that list of stocks from having an outstanding year. Our takeover list saw a return, excluding dividends, of over 71%, with Circa Enterprises (CTO.V) being the only takeover of the group going private at a 87.6% premium to our highlighted price. | | We are currently reviewing all Canadian listed companies and working on a new takeover list for 2024. Our early 2023 “Cheapies with a Chance” list did ok for the year with a 30.6% average return not including dividends. Big loser for the year was Inventronics (IVX.V) with a drop of 73.1% (not including dividends). The two big winners were Total Telcom (TTZ.V) +203.2% and Canadabis Capital (CANB.V) +147.6%. Let’s see if we can come up with some new investing ideas in our current review. | | | Cannabis was a bit of a trend for us in 2023. We don’t profess to be top-down experts but we did notice a growing number of cannabis companies turning profitable. Many looked cheap enough to get our attention and continue to do so. Most of these turned out to be the lesser-known smaller cannabis companies that were far away from the hype of yester-year. Companies like Canadabis Capital (CANB.V), Grown Rogue (GRIN.C) and Nova Cannabis (NOVC.V). We love scrounging through beaten up ex-over-hyped sectors. There always seem to be some babies thrown out with the bathwater. | | The Markets As mentioned earlier, equity markets, measured by the indexes, had a strong year. The DOW ended the year higher by 13.7%, Nasdaq was higher by 44.5% and the energy and banking heavy TSX was up by only 7.8%. The Russell 2000 was up a healthy 15.8% while the TSXV was actually down 2.5% on the year. Why did the TSXV perform so poorly? The majority of the companies listed there are money losing serial financing entities, and that was not where you wanted to be last year. | | While every dog has its day, we will continue to avoid money losing companies. At some point these types of companies will come back in vogue and get investors hyped up again. We see no reason to chase these types of companies when there are still plenty of great little profitable companies trading at cheap valuations. I’m reminded of the saying “When the wind is strong enough even pigs can fly….. There is very little wind right now. That being said, there was more wind at the end of the year than at the beginning. Going into the last few months of the year small stocks were starting to outperform large stocks. In the short-term markets, including many small stocks, seem a little overbought. | | We are still encouraged by the valuations we are seeing heading into 2024 but are somewhat less bullish than we were this time last year. We see a number of good opportunities but nowhere near the number and extreme discounted values we saw this time last year. 2023 Lowlights and Highlights I wanted to highlight some of the big winners from our universe of companies we own or follow closely. I’m sure I’ll miss a few here and there but here are the ones that really stood out for me. Let’s start with the lowlights. By far the biggest lowlight in 2023 for me was Immunoprecise Antibodies (IPA.Q). It was a brutal year for life science companies, especially those burning cash and needing to finance and that perfectly describes IPA. (Note: not all life science companies did poorly, CPH.T, RX.T and IBT.V did quite well last year). The stock had to deal with a number of internal issues along with weak investor appetite. A new board of directors and a little bit of new cash and hopefully a new brighter outlook and we’ll see what 2024 can bring to the company. Shares in IPA closed down 67.2%. Lesson learned: What goes up fast can come down fast if the fundamentals don’t match expectations. | | Inventronics (IVX.V) was a company that looked good at the start of the year but ran into business headwinds and struggled as the year progressed. We sold out earlier in the year as it became obvious that it would be several quarters at least before business conditions for the company would improve. Lesson learned: Even strong performing companies can face headwinds, and keep read company management discussions & analysis. | | Ok a few highlights, there were a lot, so I won’t comment on them all. Total Telcom (TTZ.V) +203.2% and Canadabis Capital (CANB.V) +147.6 were two outstanding performers last year and both made our Cheapies with a Chance list. Clearly any company that is growing quickly, profitable, and completely undiscovered can be highly rewarding if you find them early enough. Both fell into that category. ADF Group (DRX.T) went on a spectacular run. Highlighted as a takeover candidate, shares in DRX.T went up an incredible 231% last year. Lesson learned: strong fundamentals and cheap valuation combined with a “boring business” is usually a recipe for success. We need to find more like this. | | One stock that made it onto our mid-year 2023 Cheapies list was Thermal Energy (TMG.V). We highlighted this one as “fat pitch” and it’s quickly grown into one of my largest positions. This has almost all the things we love to see in a microcap, high rate of growth, profit, healthy balance sheet and almost completely undiscovered. The stock has climbed 88% since we highlighted it in September. We think it still has lots to go. Lesson learned: Keep digging through sedar and don’t be afraid to revisit old favourites. | | Other honourable mentions include Grown Rogue (GRIN.C) +171.4%, Kits Eyecare (KITS.T) +134.6%, McCoy Global (MCB.T) +110.1%, Enterprise Group (E.T) +97.4%, Firan Technology (FTG.T) +70%, Ibex Technologies (IBX.V) +56.6%, BeWhere Holding (BEW.V) +54.8%, Atlas Engineered (AEP.V) +50.1%, Cipher Pharma (CPH.T) +46.6%. Interestingly, many of these companies had share buy backs or aggressive insider buying over the past year. Something that I think we want to continue to monitor. As I’ve come to realise, that kind of buying has the effect of buying out and getting rid of a company’s weakest shareholders, strengthening the existing shareholder base, and making it much easier for a stock to move higher once investor confidence returns and the supply/demand balance returns to the favour of holding shareholders. If you knew where to look there were no shortages of great performing microcaps. A good mix of these types of companies and you had yourself an outstanding year. 2023 Hellos and Goodbyes In 2023 we said a few hellos and goodbyes to some things. Goodbye to the old Sedar filing system. I never thought I would utter the words “I miss the old Sedar system” but I did that plenty of times (along with some expletives) after the new Sedar+ system was launched. Trevor and I basically live on this filing system. It’s how we do most of our research and investment discovery. It’s taking quite a bit of trial and error and some discussion back and forth with the team and Sedar and we are very slowly learning how to manage the new system. Hopefully they can make some improvements to make our lives a bit easier but until then I’ll keep muttering to myself how much I miss the old Sedar… I also said hello to a new company as a member of the board of directors to Total Telcom (TTZ.V). I like the company enough to be willing to help where I can in terms of helping them with capital markets advice and bring to bare some of my satellite industry experience. Trevor and I, along with two other partners, started a new Capital Pool Corporation, Departure Bay Capital (DBC.p.V). We are actively looking for a qualifying company to merge and grow. And one more hello for me. I joined the board of directors for West Coast Kids Cancer Foundation. It’s a cause that is important to me and I hope to be able to help in any way I can. Know that part of your subscription fees and conference ticket fees go to this great charity. Looking Forward Ok, now that 2023 is in the rear-view mirror, what am I expecting in 2024? I like to talk a bit about the macro but I’ll start by reminding everyone of one of my favourite investing quotes: "The only function of economic forecasting is to make astrology look respectable." John Kenneth Galbraith. So, with that in mind here is my attempt to make astrology look respectable. In general, I am still bullish stocks, especially microcaps, for the same reason I was this time last year. Valuations for growing, profitable microcaps and nanocaps are still historically low or below the mean. There are lots of opportunities, but they are just not as cheap or as obvious as there were a year ago. So, I’m still bullish but just a bit more cautious. I expect interest rates to go lower. I also expect inflation to continue to subside, but it won’t be in a straight line down. And yes, I expect the economy to slow further. You can’t have your cake and eat it too. We need a slowing economy to fix some of the excesses we’ve seen over the past many years. I expect equity financings to still be difficult for many companies, especially small companies, although I think it will get easier by year end. That said, I still think we want to avoid companies with financing risk. One of the biggest secret threats to long term investment returns in microcaps is dilution risk. Why bother when there are many great investment opportunities that don’t come with dilution risk… I think small companies will become more in favour. Small will become beautiful again as was historically until the last decade or so. We saw outperformance from small companies over the last 2 months and I think this trend will continue and possibly increase in 2024. I think it will be driven by more microcap takeovers and more institutional money coming down market. Again, two trends that I think we saw increase in the last few months. They are both a function of increasing confidence as capital gets a bit cheaper for acquirers and liquidity improves for fund managers. Trends One of the investing trends that continues to scream at me is housing, especially in Canada. I refer to it as the easy trade. It's just a question of when. In my opinion it’s a case of mathematics. You can’t grow a population as fast as we are seeing in Canada and not need a dramatically higher supply of housing units. And now we are starting to see lower interest and mortgage rates. | | Just look at the recent uptick in Canadian building material provider Doman Building Products (DBM.T). | | We’ve already seen the uptick in housing related stocks in the US (ITB.Q) and a bit of an uptick in the larger players in Canada (DBM.T) and Adentra (ADEN.T) but I think we have a long way to go higher, and Canadian stocks tend to lag their US comparables and small stocks always tend to lag the bigger ones. You know where my big bet is in this space (AEP.V) but I think it’s time to add names to the watch list like Fab-Form (FBF.V) and other related smaller names we can find. Watch for the capital flywheel to take effect. What we mean by that is when companies get taken out or see big moves from institutional buying, that selling shareholders tend to take that cash and put it right back into other similar companies that haven't moved yet. Companies like Supremex (SXP.T), Data Communications Management (DCM.T), H2O Innovations (HEO.T), Cipher Pharmaceuticals (CPH.T) have generated tremendous returns for existing shareholders. Lots of this is driven by institutional money coming down market and some is from buyouts. That selling capital is now looking for a new home and others who have missed the boat are scouring the market for the next potential mover or take out candidate. It’s a capital flywheel in action and it’s how bull markets start. I think there are many supportive factors and why we are bullish going forward. Factors such as reasonable valuations, improving liquidity, slowly dropping cost of capital, low institutional involvement, private valuations higher than public valuations, make for a more takeover friendly environment. So, while I’m bullish going into 2024 we must keep a few things in mind. I do think that in the short term we are a little overbought in general and need to shake off some of the market euphoria we’ve witnessed in the last few weeks. There are plenty of reasons to continue with our strategy of finding growing, profitable and undiscovered smaller companies at reasonable valuations. Opportunities are waiting for us to find them. Many of our stocks still look cheap and there are always new ones to review. I also think we need to be careful we aren’t selling our winners too early. We tend to have recency bias, thinking that what we’ve seen recently is likely to be the case going forward. Many stocks were extremely cheap and now, even after having risen, are just a bit less cheap. If I’m right and if condition play out as we think they might there is a long runway ahead for these types of microcaps Keep an eye out for a couple of new lists from. We should have a new list of companies including a new takeover list and a top buy list for our portfolios. So, with all that let’s set out to have a great year in 2024. There are lots of reasons to be bullish and lots of new investment ideas waiting for us to find them. To your wealth, Paul and Trevor |
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