Markets Happy Canada and Independence Day! I hope everyone is enjoying their long weekends for those in Canada and the US.
Equity markets were buoyed by cooling inflation data and some better than expected US economic data. The DOW was higher by 2.0%, Nasdaq rose 2.2% and for a change the TSX led the pack with a 3.8% gain. |
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Markets rallied to end the quarter. We’ve reached the halfway mark for the year and interesting to note that Nasdaq has had a big move higher in the six months, up 38.9% since the start of the year far surpassing the other major North American equity indexes. The DOW rose only 3.6% and the TSX up 3.4% in the first half. |
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Financials The US dollar index closed slightly higher on the week. |
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The Canadian dollar pulled back versus the US dollar. |
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Treasury yields climbed further this past week with short term rates climbing faster than long terms rates which historically have indicated and elevated recession risk. |
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The Canada 5 year bond yield ended the week roughly at the same level as the previous week. |
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Commodities Gold finished dropped for the third week in a row finishing the week at $1929.40 and is up 6.0% year to date. |
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Oil had another lack luster week and continues to trade in a tight range with WTI oil trading a few dollars above or below $70 closing the week at $70.64. WTI oil is down 9.9% year to date. |
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Natural gas, also known as the “widow maker” amongst commodity traders, continues its volatile ways. North American (Henry Hub) natural gas future prices are up 29% for the month of June but natural gas is down 38.6% year to date and down 73.1% since its August highs. Natural gas trading is not for the faint of heart. |
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Baker Hughes drill rig data shows a drop of 8 rigs active in the US and a drop of 2 rigs in Canada https://rigcount.bakerhughes.com/
Stocks It’s been a surprisingly stronger first half of 2023 than many prognosticators predicted. The commodity bull market whimpered out and tech and home builders’ stocks were much stronger than expected. Inflation and higher interest rates weren’t enough to keep certain sectors from performing very well. Artificial intelligence was a big theme in the tech space helping NVIDIA Corp (NVDA) climb 190% |
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while a housing shortage and continued pent up demand for housing helped publicly listed home builders like Builders FirstSource (BLDR) climb 109% since the start of the year. |
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Meanwhile, the energy sector which looked primed for a continued move higher was one of the first half’s bigger losing sector down 6.4%. |
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Had anyone been too bearish at the start of the year they likely missed some good gains. It also highlights how important it is to leave the forecasting to the weatherman and in my case to concentrate on stock picking rather than macro forecasting. This market was and continues to be a stock pickers market.
Microcap stocks that have done well in the first have share several similar traits. Most are profitable, higher insider owned, lower float, less speculative companies, in basic industries, some would even say boring companies that started the year with low valuation metrics. Companies that were able to support or augment their share prices through share buy backs held up better than cash burning companies so prevalent in the microcap space. And it makes sense, cash rich companies have the choice of generating higher interest on their cash piles or, if prices make sense, allocate that cash to investing in shares of themselves. These came with the added bonus of not needing to find favor with the investment banking community.
Here's a few of the companies in our universe that performed well so far in 2023: ADF Group Ltd (DRX.T) +82% |
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Data Management Corp. (DCM.T) +101% |
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IBEX Technologies (IBX.V) +41% |
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Atlas Engineered Products (AEP.V) +56% |
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Hammond Manufacturing Corp. (HMM.A.T) +46% |
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Total Telcom (TTZ.V) +122% |
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All these companies are generating free cash flow and their stocks have significantly outperformed the indexes. Apart from DCM.T which raised equity financing for a major acquisition none of these companies have need to raise money.
A great example of two companies on polar opposite sides of the cash generation and cash burn side are CanadaBis Capital (CANB.V) and Canopy Growth Corp. (WEED.T). |
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Guess which company is making money and which one isn’t? Two very similar companies in the same industry but two very different looking cash flow statements…
There seem to be two distinctly different kinds of stocks in the microcap space right now, those that are generating their own cash and those that are burning cash. The majority of the microcap stocks that have outperformed in 2023, so far, are those companies that are not dependant on outside sources for capital. And with the cost of capital being what it is today, those money burning companies are going to find it even more expensive to go to market for that growth or life saving cash.
Other Stuff The markets still feel too ahead of themselves right now and maybe it’s because summer is calling, I’m just not too interesting in doing much in these markets. I don’t mind nibbling on a few names but just don’t see enough share price weakness to buy some of my favorites. Without much need for fresh capital and unless some of my positions fundamentally stumble, I doubt I’ll be doing much adjusting of my portfolio, if any. It’s time to pull up the deck chair and spend some time poolside. Maybe double down on my reading and combing of the Sedar website.
We keep looking for new ideas and while it’s getting hard to find the obvious opportunities like we did at the end of 2022, we know it just requires a bit more digging and maybe using a different lens.
We are spending a bit of time reviewing some old names and some new names in something I refer to as the “Good, the Bad and the Ugly”. The “Good” refers to great little companies with a good income statement and balance sheet. The “Bad” refers to the companies with bad income statements and bad balance sheets. The “Ugly” refers to companies with a good income statement and an ugly balance sheet.
Many investors will stay away from companies with a bad balance sheet even if they have an improving income statement. I think that can be a big mistake. It’s my experience that companies with a strong income statement (i.e., profitable and growing) can be overlooked and misunderstood if they have a bit too much debt or some shorter term cash obligations. This can be where great opportunities present themselves. One recent example is Zedcor Inc. (ZDC.V). They’ve been able to grow themselves out of a weak balance sheet. One of my big wins from the past, and another “ugly” stock was Hamilton Thorne (HTL.V).
Hamilton Thorne holds the distinction of being our first recommendation when we started SmallCap Discoveries in 2014. The company at that time was showing strong revenue and earnings growth yet was hindered by debt that was misunderstood by the market. If you didn’t ask the right questions, you’d think the company was being dragged down in short term liabilities. This turned out to be the opportunity. We approached the company and offered to do an equity offering that would allow them to pay down some debt and “clean up” the balance sheet. The company agreed and we did a financing at $0.10 with a $0.20 warrant. Once the financing closed the market woke up and investors no longer viewed it as risky as they did before. The stock immediately more than doubled and within a few years we had our first “10 bagger” for our subscribers. |
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It’s a great example of what can happen when you focus on the income statement over the balance sheet on these small companies. In my experience it’s much easier to fix a broken balance sheet than a broken income statement. If the company can generate cash, then it’s significantly increased its ability to fix its balance sheet and sometimes offers savvy investors an extra opportunity to help in the process.
One company that Trev and I are looking at to determine if it’s an “Ugly” company is Cleantek Industries (CTEK.V). Decent and improving income statement, ugly balance sheet. |
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Sometimes ugly companies turn out to be bad companies, it takes a fair bit of work to determine which is which, but it can be worth the effort when you find some of these misunderstood opportunities and are able to further take advantage of these opportunities by flushing out the selling or take part in a financing.
It might be time for another list…. Trev, pack up the deck chairs, time to get started on a new list…
This week I’m reading: The Art of Execution – Lee Freeman-Shor - How the world’s best investors get it wrong and still make millions. Only a few chapters into this one but I can tell it’s a great one and will likely make my recommended reading list. This one will really help you refine your holding strategy when it comes to your investment portfolio. It’s comforting to know how often the world’s best investors get it wrong yet can still do so well.
To your wealth, Paul and Trevor |
