Grain prices appear to have stabilized but attention continues to be on the Black Sea trading maritime corridor from where Ukraine ships most of its grain products.
Stocks
I continue to stress the fact that while bigger markets get the headlines the smaller stocks have been ignored and almost shunned by investors. I believe many investors are being distracted by the constant negative headlines and market sentiment is swayed by the poor performance of the old market leaders.
There continues to be a rotation from the old tech leaders to a new batch of up-and-coming companies who won’t become well known names until they have moved significantly higher than current levels. I mentioned a few companies above but there are many more that are in their own bull markets. I suggest you take a few minutes every week to review the new 52 high lists. As I mentioned this past Friday there were 70 stocks hitting a brand new 52 week high on Nasdaq. There were another 76 stocks on the NYSE and another 9 stocks on the TSX exchange (3 of which were energy service companies). The new market leaders are already claiming their ground. They are climbing the wall of worry that so many investors are subjecting themselves to.
It's difficult to have the courage to go against the trends you see. Big markets have been going down for many months now. Investor sentiment in general is quite weak. News headlines sound almost apocalyptic. Investors are full of fear. Who in their right mind would want to invest in stocks when things seem so bleak? It’s counter intuitive but this is precisely the reason you want to be looking to invest right now. “Be fearful when others are greedy and greedy when others are fearful” Warren Buffett.
I am not trying to determine whether Google is a good buy right now, nor Amazon, Apple or Facebook. I’m looking for the new leaders. And this dismal investor sentiment is giving me mispriced opportunities and quite frankly giving me time to do my due diligence. When things were ripping higher you had a few hours if not minutes to determine if a news release was worthy of attention. In many instances these days good news sees no reaction by investors or in some cases it’s “let’s sell while we have a chance” on any news that brings in a little bit of buying. Certainly, that’s been the case in many of the illiquid nanocaps we follow.
In my opinion this is the time where generational wealth can be created. Many of these small companies will go on to grow into much bigger companies. Some will become multi baggers. A few will go on to become household names. It happens every cycle.
So how can we build the courage to invest in some of these companies when the environment seems so confusing and uncertain? Let’s not look to buy stocks, let’s look to buy a business.
People buy businesses all the time. Some are small and some are large, some are growing fast, and some are steady businesses. Then there are those that start a business from scratch. Whether you’re starting a business from scratch or buying an existing business the biggest risk, I would argue, is in not doing your due diligence. If you want to start a new business you need to educate yourself on a number of things including cost of building your new widget to supply and demand, to the competitive landscape and much more. When starting a new business there are a number of things you will only learn after you’ve started. When buying an existing business there are just as many things you need to know but in some ways the information is easier to get. Usually there is more certainty in buying an existing business. The business has a history, it may have trends you can analyse, it may already have an existing product in demand and customers willing to pay for it at a profit for the business. And the financial data can be reviewed to determine how well the business has done in the past under various economic conditions. There is a long list of information a savvy buyer looks for in determining whether they should buy a private company.
These things you need to make a buying decision on a private business hold true for publicly traded companies as well. In many ways the information you need for your due diligence is much more easily available with public companies. The conviction you would need to buy a private business could be extremely high. After all, this is likely to be a significant portion of your wealth you’d be investing in a business and the holding period would likely have to be measured in years if not for your lifetime.
What if you took this same effort and used it to invest in a publicly traded company? Would it change how you would search for the stocks you would look to buy? Would it change your process and strategy? Would it change your time frame? Would it change your conviction level?
I find some of the best investors I know are, or were, business owners. They treat buying a stock like buying a business. They tend to ask different questions when researching companies. They also tend to have longer time horizons on their potential investments. They also seem to be more risk averse yet are not afraid to buy small companies. They don’t see risk the same way as many investors do. Risk isn’t a matter of size it’s much more about proof of business execution and the margin of safety. They tend to like to buy decent businesses that look cheap. Businesses that have proven themselves but are offering an opportunity that they can see gives them good upside if things stay the same as they currently are or improve. They don’t like to speculate on something different happening. This all helps them build a higher level of conviction to their investments.
Are you an investor or a speculator?
I like to say speculators bet that something new will happen to change the company fortunes while investors bet that things just keep staying the same. A company that consistently grows by 10% and maintains steady margins is likely not going to appeal to a speculator. He’s more likely to bet on a company with a new widget that promises to change an industry and one day bring great profits. The company has yet to prove that it can finance the building of the organization and make this new product, find a buyer, have that buyer pay a price higher than the cost of that product, in quantities that can allow the company to generate a profit all before running out of cash. Oh, and do it in a timeline that justifies the current price of its shares.
An investor simply wants to buy a company for less than he thinks it’s worth and for that company to keep doing what it’s been doing. Find a business that is doing well, where it is obvious that trends should continue or that if they don’t the value still justifies the purchase, again, buying with a price low enough that these is a significant margin of safety.
Some microcaps and nanocaps we follow are an investor’s dream right now. Good, solid trends, solid long-term outlooks yet at multi year low valuations. These valuations are more a function of investor sentiment and capital flows into big stocks over small stocks than anything wrong with the companies offering what I would suggest is that margin of safety I’m talking about.
It’s important to build conviction in the current investing environment. That might not mean that you rush out and buy the first thing you think is cheap, but it should mean that you’re willing to do the work to find the opportunities. That’s just the first step and it’s hard when everything appears so bleak but it’s a big step towards having the courage to buy something when others won’t. It’s the only way to get that big margin of safety that a true investor needs to succeed.
Next week, I’m going to show you some of the due diligence I use to build conviction in my investments. I’ll walk you through an exercise I use as if I was buying the whole company. It’s what I do with my biggest conviction holdings, does an investment pass the buy out test.
Other Stuff
Inventronics (IVX.V) announced Q3 results this past week. The company reported its 3rd best quarter ever. Revenues were up 8% over Q3 2021 and after-tax earnings were down 44.5%. However, pre-tax earnings were up 27.2%. The recognition of the deferred tax benefit of non-capital loss carry forwards increased net earnings in the prior year. The stock sold off on the news and we believe current prices below $3.50 and a trailing 12-month PE of 7.2 the shares offer a very strong risk/reward opportunity at current levels.
Circa Enterprises (CTO.V) released Q3 results. Revenues increased by 8.8%. Earnings, however declined by 68%. "Circa's sales for the third quarter of 2022 increased over Q3 2021 on stronger sales in both segments. However, the improved sales did not translate into higher earnings, largely due to supply chain and labour disruptions in the quarter.” Cory Tamagi, Circa's president and chief executive officer, stated "Management expects the metals segment sales to continue its strong run through the fourth quarter and into 2023 as demand across most regions remains steady and it delivers the backlog orders. The telecom segment continues to see increased quoting activity, particularly in the U.S. market. Opportunities in the U.S. have increased with the addition new distributor representatives and increased in-person representation.”
The company performance tends to be lumpy and while this quarter’s earnings were weaker due to supply, and logistics issues the company still had it’s second strongest quarter of revenues. With robust product demand and an adjustment to current supply and labour conditions the company should be able to improve its bottom line. The company’s shares last traded at $1.37 and are priced at 8.35 times trailing 12-month EPS. We have a call scheduled with management this upcoming week.
Keep an eye on Bri-Chem (BRY.T). With the strong results from a number of North American energy service companies including a number of the drillers, I expect we could see strong Q3 results for the company. The stock moved nicely climbing 14.5% on the week but is still well off its year high. It continues to be my favorite nanocap energy service company.
