Smallcap Discoveries: Weekly Update: September 4

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Subject: Smallcap Discoveries: Weekly Update: September 4 - 8

September 4 - 8

Market Commentary

Market

North American equity markets all trended lower this past week as higher oil prices and lower than expected US weekly jobless claims increased fears that interest rates may stay higher for longer. By Friday the DOW was down 0.7%, Nasdaq was lower by 1.9% and the TSX fell 2.3%.

Financials

It’s all about interest rates right now.

The US 10 year treasury yield continues to stay persistently elevated near multi year highs but has tested these levels several times in the past year but can’t seem to break higher. A break above 4.35% or a break below 4.00% likely determines the next direction. Equity markets will cheer a break below 4%.

Softer economic data in Canada has the Bank of Canada pausing any hikes in interest rates for the time being. The BOC decided to keep rates where they were and will take a wait and see approach to prevent from overtightening into a slowing Canadian economy.

The lack of an increase in rates took some pressure off the Canada 5 year bond yields and helped drive the Canadian dollar briefly below $0.73 vs the US dollar.

And speaking of the US dollar, slightly more robust US economic data and the “risk off” sentiment of traders pushed the US dollar index back above 105 a level it hasn’t seen since early March.

Commodities

The focus is back on oil prices as the recent 37% climb off the recent lows have economist concerned for a return of inflation. Saudi Arabia and Russia’s extension of production cuts are helping prices maintain an upward trend. WTI oil closed the week at $87.58, levels we haven’t seen since December of 2022.

North American drill rig activity remains subdued. According to Baker Hughes there was 1 more active drill rig in the US and a drop of 5 active rigs in Canada. Even though rig counts have been declining steadily for many months we’ve been seeing good strength in a number of larger energy service companies and this strength has finally begun trickling down into the smaller players.

Gold trading continues to stay in a tight trading band. The next big move in US interest rates likely determines the next direction for gold prices.

Stocks

The big markets continue to feel overbought to me. Economic uncertainty, higher treasury yields and historically lofty prices for big stocks makes me think that we have a possible set up for some shocks to the markets. I’m much more comfortable owning cheaper microcaps. I know, I know, a down draft in the big stocks likely brings a down draft in the small ones too, but valuations do matter no matter what size of company.

When I talk to many investors and brokers that work in the microcap universe, the pessimism is about as bad as I’ve seen it. You’d think we’re in the depths of a bear market or maybe the dark ages of microcaps. There is no joy in microcapville, at least not for those that survive on smallcap financings and promotion. Looking at a 20 year chart on the TSX Venture Exchange I can see why:

But it's not all doom and gloom in microcap land. There are small companies whose share prices are climbing and surprise, surprise most of them are profitable microcaps. Some microcaps hitting new 52 week highs this past week include Grown Rogue (GRIN.V),

Hammond Manufacturing (HMM.A.T),

Colabor Group (GCL.T),

Cipher Pharma (CPH.T)

ADF Group (DRX.T)

and Zedcor (ZDC.V).

There are over 2700 publicly listed companies in Canada. Roughly 2300 have a market cap under $500 million, and as of last quarter we counted 313 that were profitable for their last year. Of those that are growing, the number is considerably smaller still. This is the pool of stocks we want to focus on.

While there are plenty of large caps hitting new 52 week highs most are sporting quite high price to earnings multiples, I’ll stick to the profitable microcap companies growing at double digits and trading at single digit PE ratios.

Other Stuff

This past week I was honored to be the keynote speaker for the Planet Microcap Investors Conference. Trevor and I spent 2 days listening to some great speakers and company presentations. It was my first in person conference since before the start of the pandemic. It was great to meet up with many people I haven’t seen in person, in years.

I managed 18 different 1 on 1 meetings with company management. All part of the process of “flipping over more rocks” as Peter Lynch would say. With over 2700 publicly listed companies in Canada it’s important to review as many companies as possible. It’s part of the process of casting as wide a net as you can to find the half dozen or so standouts every year that hopefully turn out to be multi-baggers.

There were a few companies at the conference that I was familiar with such as Data Communications Management (DCM.T), MediaValet (MVP.V), Kraken Robotics, (PNG.V), Microbix Biosystems, (MBX.T), and a few others but there were also a lot that I wasn’t too familiar with. Some that stood out to me, although don’t quite meet our buying criteria (yet?), include names such as C-Com Satellite, (CMI.V), Tantalus Systems, (GRID.V), Global Crossing Airlines Group (JET.NEO) and Simply Better Brands (SBBC.V) and even tiny little EarthRenew (ERTH.V)

Getting a chance to meet with management gives us a better understanding of the companies and now we can watch for certain catalyst and possible financial inflection points. All have very interesting stories, some have strong revenue growth, but have yet to turn consistently profitable. We’ll put them on the “wait and see” pile for now.

This Week I’m Re-reading: The Outsiders – William N. Thorndike – Eight Unconventional CEOs and Their Radically Rational Blueprint for Success – This is a great book that deserves to be read over and over.

To your wealth,

Paul and Trevor

Buys and Sells This Week