Learning From Losing Money In MicroCaps

Ian Cassel Blog, Educational 6 Comments

“We may impress people with our strengths but we connect with people through our weaknesses” – Craig Groeschel

Talking about your winners all the time might lift the ego and attract lemmings, but it will do little towards gaining the respect of your peers. I picked the right stock, it went up, boy I’m smart and wasn’t that impressive. No, what I truly enjoy talking about most are my losers because I’ve had plenty of them, and I believe lessons can be learned from analyzing the losers. I’ve been a full time microcap investor since 2008, and I still make stupid mistakes. The key is learning from your mistakes. The difference between Major League Baseball players consistently hitting .230 versus .330 BA is $15-20 million per year. Keeping your losses small in the portfolio is just as important as holding on to your winners.
One of my first big losses came in 2000. I swear I was trying to lose all my money as fast as I could. I bought a tech stock at the top of the internet bubble based off a brokers recommendation. As the stock dropped I was told to dollar cost average, so I bought more at $100, $80, $60, $40, $10, and $5. The stock eventually fell to $0.32 per share, and I gave in and sold at $0.55. I ended up losing 97% of my investment. In the Guinness Book of World Records, my name is highlighted next to Quickest Loss, and Biggest Sucker. This wouldn’t be the last time I would lose almost everything, but losing money is a great educator and motivator. These early losses are what eventually guided me to microcaps, and a year or so after this big loss is when I met my first microcap CEO.

The reason why we love microcaps is they are one of the last investment classes where you can get an edge. That edge is information, and it may simply be nothing more than knowing a company exists. The information edge goes both ways.  Not only can having an edge get you into a position before the masses, but it can also get you out of a position before the masses sell. When events occur that challenge and change your investment thesis, the fact that you are aware and sell quickly can save you lots of money.

All investors struggle with justifying or rationalizing their positions. I can’t tell you how many times I’ve held a position way too long after something negative happened.  Instead of selling based on my gut instinct, I rationalized my position, convincing myself to hold or maybe even buy more. In almost all of these instances I lost a substantial amount of money. When you know your positions better than most, you’ll know when the story changes. When the story changes it’s almost always time to sell. Don’t rationalize your investment. When the investment thesis starts cracking, you start to sell because everyone else will when it becomes obvious. Here are a few real life examples when rationalizing my position cost me hundreds of thousands of dollars:


Example #1, Sudden CFO Departure: On more than one occasion I’ve been a shareholder in a company where the CFO suddenly resigns.  CFO’s leave companies all the time, but it’s important for the company to telegraph the departure months before it actually happens so shareholders aren’t surprised.  Bad things can happen when a company provides little warning. When a CFO resigns, questions get raised, Are the financials in order? Is there fraud? The types of questions that if true can completely derail a stock. In many ways this is worse then even the CEO resigning suddenly. When a CEO suddenly resigns, most people just think he probably got caught sleeping with the secretary or something (Just kidding). Heck, in certain situations the stock might even rally if a CEO resigns 🙂  A few years ago I held a position after a CFO suddenly resigned. I thought it was odd because I spoke with management frequently and I never got the impression they were searching for a new CFO. I convinced myself to hold while the stock dropped. A month later the auditor resigned from the company, and the stock got cut in half.  A month later most of the board resigned. Two months later the stock went to zero. This is an extreme example, but I’ve found in these scenarios it is much better to shoot first (sell) and ask questions later.


Example #2, Industry – Consumer Shift: In 2009, I bought a 3-4% position in a company called Global Axcess (GAXCQ) between 0.40-0.60. The company managed a portfolio of 5,000 ATM’s machines across several states. If you know much about the ATM business, their profitability is inverse to fed funds rate changes because the cash they put in the ATM’s is borrowed. If the fed increases the fed funds rate, it basically squeezes the margins of the ATM operators and vice versa. As you remember, the fed funds rate was lowered significantly in 2008-2009 to thwart an economic depression. This was inherently good for GAXC’s ATM business.  I bought the stock because of increasing margins of the ATM business, but soon after management announced an exciting new venture. At this same point in time RedBox DVD Kiosks were bursting onto the scene and their growth was exploding. GAXC thought why not leverage their ATM experience by rolling out DVD kiosks. It sounded good to me. RedBox was a hot stock and if little GAXC could be successful rolling out their DVD kiosks, this is something that could really increase the valuation. On the news of entering this space, GAXC stock went over $1.00. Literally within a few weeks of GAXC entering the DVD kiosk space, NetFlix (NFLX) started to really gain traction, which instantly sucked the buzz out of the DVD kiosk plays.  You could just feel it.  As a shareholder, I’ve never been in a company whose opportunity opened and closed literally within a couple months like that. The industry shifted. The difference between an industry/consumer tailwind vs headwind is huge. It’s the difference between a 50 PE and an 6 PE. I waited too long rationalizing my position, but I should’ve sold it immediately. The debt the company took on to fund the DVD kiosk expansion eventually bankrupted the company.


Example #3, Economic Shift:  In 2007, I bought a big position in Dale Jarrett Racing (DJRT) between 0.10 – 0.20. The company operated an authentic NASCAR racing experience at several racetracks around the United States. I took several friends and family from PA down to Talladega Motor Speedway in Alabama to experience the thrill of racing 180 mph in authentic stock cars. Everyone loved it. It was exhilarating. I liked the company because it was profitable and trading at a $3 million market cap. If the company was successful in marketing and filling up their racing days at the track the company would become very profitable. There was also talk of partnering with a major casino or brand and building a track in Las Vegas. Remember this was 2007 and Las Vegas was in full bubble mode.  The company was going to significantly increase their advertising dollars over the winter of 2007-2008 to fill up more track days in 2008.  By my calculations, if the company increased their racing days as much as I thought, the company could earn another 0.02-0.03c EPS, and this could be an easy 4-5 bagger.  If you remember we started to see the economy start to get sluggish around this same time while the company was aggressively advertising. Consumers were just not willing to spend on luxury purchases such as this when the economy was heading into free fall. I justified the position and held on, and the longer I held the lower the stock fell.

We all take losses from time to time, but the important thing is learning from them. In most of my large losses I ended up rationalizing my position. When you start to see signs of weakness in your investment thesis, it’s human nature to try to justify that position and convince yourself to hold on. The hardest thing to do is to admit things have changed and you are wrong.  Remember the “edge” that we enjoy in microcaps is one of information. Use the “edge” to buy and also to sell.  Keeping a pulse on the company while monitoring outside forces affecting the company are key in successful microcap investing. When things change, gauge the situation, but react quickly. It can mean the difference between a capital gain, and a large capital loss.

If you enjoyed this article, you will like Cutting Your Losses.

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Comments 6

  1. Boy, I can beat that! I’ve been buying microcaps since 1958, and not only do I still make mistakes, I make the same mistakes. Maybe not as often. And I do have nice little gains from time to time, to keep my head in the game. However, I have come to formulate a couple of mental rules that I try to follow. One is that if the chart looks like the stock is in free fall or ready to go there, I get out. I use the purple crayon method, that is, I don’t use a fine line to see if the stock is just barely breaking down, but a thick line of color that clearly shows something is wrong. Another thing is to stop rationalizing. This goes along with the notion that although the stock is clearly falling, I don’t try to justify continuing to hold the position. This is a difficult decision, because I am an investor, not a trader, and I take a position under the assumption I am going to be around for a while to see if the little company can fulfill its promise. But usually, it is best to go, because so many people have been disappointed that the stock will have to overcome a lot of tax sales even if they do finally deliver the goods. The third thing that I have learned is that if I have bought into a company because of a certain product or service is supposed to make their fortune, and in the midst of that the management decides to undertake a new effort or unrelated product, they are wandering into unfamiliar ground. I didn’t buy the company for that, and it introduces a big unknown into the mix. The one thing I’ve consistently done right over the years is to jettison stocks that have suddenly gotten a new big thing to work on. This is especially true if the company changes its name to reflect its association with the current fad. Nonetheless, I still make mistakes. I make fewer of them in bull markets, however. How curious is that?

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      Thanks for your thoughts John. Yeah you are right, in bull markets mistakes get muted a bit as the rising tide lifts all ships. I’ll probably turn this blog post into a series. We have a lot of experiences to share on the club on this topic.

  2. This article may also have been titled “ The cost of an investing education”.

    In this case, one enters the learning zone as a babe in the woods and all the wolves are salivating. You are stupid. Surprisingly, this point was made rather clearly as I listened to more than a few people at the MCC Philly meeting who revealed that they damn near lost everything when they were young and stupid.

    The issue is how long does it take for you to become “not stupid”, and I will not concede that one can graduate as a summa cum laude from this “college”. Question is: How much does it cost you to progress from Loser to calm investor?

    Mostly what I think we learn is the “don’t”, since so many actions end up being traumas that you want to avoid. Ian has expressed a few. The lesson learned can be quite costly and as a result, they stick with you – possibly define you (or define your strategy)

    Here are some lessons:

    Never operate in margin – you will be screwed
    Never love a company – it’s just a business
    Only buy stocks that are trending up if you are long
    Never hold if the trend reverses to down
    NEVER double down since that is a sucker’s play
    Use stops – repeat use stops (may be hard on thinly traded stuff)
    You do not control right or wrong, that is controlled by the market.
    You will be wrong! Deal with it.
    You can always buy back if you were wrong, took profits or whatever
    Did I say that you could/will be wrong – suck it up and GET OUT!
    The chart and price action tells you what people think of your “good idea”
    Set a strategy:” I will only allocate X% of port per trade and exit on Z% loss”
    Just don’t lose the money – well just don’t lose too much money
    If you are losing – STOP, exit the market, go on vacation, get out!
    No matter what, you are still an amateur – deal with that too!
    It is best to remain fearful – as if everyone wants to screw you.
    The BIG test is if you can make $$ in a down market.
    The totality of all this is: MONEY MANAGEMENT
    The other totality of all this is: FORGET YOUR EGO.

    The primary objective is to learn how to be emotionless in this game. You win, when in the end your emotion score is ZERO.

    One succeeds when all of the lessons are executed.

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      Great summary Kevin. See I could have set it in 200 words 🙂

      I think it’s hard to really learn these principles until you lose money. It doesn’t mean you have to lose a lot of money. You can’t learn the skillset it in a book or even taking other peoples advice. Especially in microcap, most who lose money never invest in the space again because they didn’t know what to look for in the first place. It’s the ones that choose to stick it out, figure it out, and learn from others along the way.

      1. All your investing problems would be solved if you were able to find an EARLY a multi-bagger and accumulated a large position. Let me quote Stanley Druckenmiller on the lesson he learned from George Soros(from the interview in The New Market Wizards book by Jack Schwager). “It’s not whether you are right or wrong that’s important, but how much money you make when you are right and how much you lose when you are wrong. When you have tremendous conviction on a investment, you have to go for the jugular. It takes courage to be a PIG. When you are right on something you can’t own enough.” This is not often not an easy formula to follow in microcap stocks. But it will pay big dividends if you have early knowledge and aren’t afraid to be a PIG. As of right now I must credit Ian for his early analysis of Nobel Roman’s last year. Getting in late last year with a big position has helped me greatly to this point.

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