Turnarounds

Prior to the 19th century people would wait until 12:00pm (noon), when the sun was directly overhead at its highest point, to synchronize their clocks and time pieces. Of course, this meant every community had its own time.

Noon in Washington was 12:02 in Baltimore, 12:12 in New York, and 12:24 in Boston. Back then, people didn't travel far very often, so it didn't really matter if one place's time was a bit different from another's. In the early 1800's there were over 300 local times in the United States.

The railroads changed everything. In 1830 there were 23 miles of railroad track. By 1850, there were 2,000 miles of track. The Civil War spurred an explosion in railroad construction resulting in 80,000 miles of track by 1877. People could travel further faster and time differences became more important. Several rail car accidents occurred resulting in fatalities due to train schedules not synchronized to the correct time. The railroads set out to solve this issue. 

On November 18, 1883, America’s railroads began using a standard time system involving four time zones, Eastern, Central, Mountain and Pacific. Within each zone, all clocks were synchronized. It took until the passage of the 1918 Standard Time Act for the time zone system to become official throughout the United States. 

The key in investing is finding growth in value. You want to find something that is undervalued that can get overvalued. I’ve found you make the most money by having a 1–3-year variant view on a business and buying the stock before the business turns up, inflects, or accelerates. You must be willing to buy and hold dead money and look wrong before you’re right.  

As microcap investors we normally don’t have our investing time pieces synchronized with reality. We buy a train ticket, but the train arrives late or never at all. In microcap, we are often too “early” to the turnaround, catalyst, acceleration of growth. 

I’ve found I’m normally 2-4 quarters earlier than I think I am. This is why position sizing in turnarounds is so important and keeping the position smaller than you want it to be. 

The exception is when you actually get the timing right. Winning normally looks like sitting on dead money for 1-2 years longer than you thought and then having the stock triple in a month.

Being early and having to wait a few more quarters is a curse in the short-term, but a blessing in the long-term. It forces you to dig in and really form the conviction to hold. You form deeper conviction when you are forced to wait. “Delayed Gratification” would be the best investing book title. 

Stocks rarely perform in the time frames we predict, and it’s why the market only works for investors that have more patience than they thought they would ever need. 

Being early isn’t an issue unless the business is losing money. Money losers are always targeting profitability within 12-months, and then it takes 24 months longer. This could mean 1-2 more dilutive financings which could turn an above average IRR into no IRR. It’s why it’s important to at least find a company that can tread water (breakeven) while you wait. This way if you are wrong, you won’t lose much. 

A microcap investor’s biggest risk is dilution. Find companies that can self-fund their growth so you can afford to wait for the train. If the train doesn’t arrive, you won’t lose the money you spent on the ticket. You can transfer it to another train.  

Turnarounds are exhilarating when you get the timing right:  

1. You establish a 1–3-year variant view on a business. Variant = the business is better than most investors think. 
2. You buy a few quarters ahead of the inflection/acceleration when the stock is still hated, misunderstood and cheap.
3. You are willing to look wrong before you are right and hold dead money. 
4. You realize you were 1-2 quarters earlier than you thought. This is fine if the business is profitable. 
5. The business suddenly turns, inflects, accelerates, and the stock goes up 100% in a month. All your peers that passed initially are starting to get interested. The best investments are the ones your peers won’t agree with/look at until after they go up 100%+.
6. Then the business puts up a second surprisingly good quarter, and the stock goes up another 100%. 
7. Then the business puts up a third surprisingly good quarter, and the stock goes up another 100%.

The opportunity in most turnarounds is the majority of investors only remember the company for what it was. Even after a new management with a new strategy starts to execute there is an extra 1-2 quarter lag in the stock taking notice. The "re-discovery" process is a function of management execution + slow converting of non-believers.

Here is the investor psychology of a hated/misunderstood turnaround stock as the business turns up:  

• 5 PE = Value trap. Dogsh!t business. 
• 10 PE = They had a decent quarter, but I don’t trust it.
• 20 PE = Two quarters does not make a trend!
• 40 PE = Three good quarters. This is a high-quality business with an Outsider CEO. Back up the truck!

One of the hardest parts of turnarounds is holding onto them as the business transitions from a value multiple (not valuing the future) to a growthier multiple (valuing the future). You need to grow with your investments to hold on and capture the right tail of life changing returns.

It’s hard to hold onto a stock that gets a little expensive when 90% of the reason you bought it was because it was cheap. You are anchored to what it was, not what it is, or what it could be. It’s hard to pull up that anchor of value and raise the sail of growth. 

It's the same as past relationships. There are plenty of people that only remember you for who you were when they knew you. 5-10-20-30 years ago when you were a different person. Sometimes you cringe when you see certain people because they remind you of the person you used to be. You aren’t that person anymore. You've grown. It’s the same with companies.  

On MicroCapClub we have over 1000 microcap companies profiled. Here is a little secret. The best ideas often aren’t the 10-15 new ideas posted per month, but the ideas that were posted 1-5 years ago where the story/thesis has evolved but no one has paid attention.

Every microcap I analyzed/almost bought a few years ago is a different situation today. They are basically a new story. It’s too easy and lazy to say, “I’m sure it hasn’t changed”, and then 6-12 months later you see someone else who took the time to read the transcript, talk to management, do the work, make the 500% return on it that you should have made. The best stock pickers are those that make the extra effort to look at old ideas through fresh eyes.

Most microcaps are turnarounds stories. 

Most microcaps are underdog stories. 

Most microcaps are underestimated. 

Your greatest achievements occur when the odds are against you. When people have underestimated you and your potential. When all they remember is your past mistakes. They haven’t stayed in contact to see how much you’ve grown and how hard you've prepared. They don't see you coming, but they soon will.

Most turnaround stories are just like you.

_{MicroCapClub is an exclusive forum for experienced microcap investors focused on microcap companies (sub $500m market cap) trading on United States, Canadian, European, and Australian markets. MicroCapClub was created to be a platform for experienced microcap investors to share and discuss stock ideas. Since 2011, our members have profiled 1000+ microcap companies. Investors can join our community by applying to become a member or subscribing to gain instant view only access. MicroCapClub’s mission is to foster the highest quality microcap investor Community, produce Educational content for investors, and promote better Leadership in the microcap arena. For more information, visit https://microcapclub.com/ and https://microcapclub.com/summit/}