The Best Microcap Investor You’ve Never Heard Of

Chip Maloney Blog, Educational 17 Comments

When I first started researching individual stocks, I initially decided to expand my search to the entire North American equity market. There was an investment firm named First Wilshire Securities that was showing up on a number of microcap companies I examined. I’ve never been shy of stealing stock ideas from smart investors, so I started to look deeper at some of the other holdings in First Wilshire’s portfolio for potential ideas.  I found that many of these companies turned out to be really interesting ideas trading at attractive valuations; this spurred me into needing to find out more about First Wilshire Securities and the person behind the firm.  This search in turn led me to discover a superinvestor named Fred Astman who helped shape my early investment philosophy as much as any other investment master.

For his amazing track record, very few investors have heard of Astman. He spent his entire investment career under the radar. There has been very little written about Astman, however, he did do a handful of interviews with The Wall Street Transcript and The Bowser Report over the years.  A few short profiles of Astman also appeared in BusinessWeek, Equities, and a few other business publications. In this article, I tried to distill what I learned from these sources.

Fred Astman was born on May 29, 1922. He served in the U.S. Air Force during World War II and when he returned from service overseas, he earned a business administration degree from the University of Connecticut.  He was later recalled to active duty during the Korean War. Following his active duty, in 1961 he became a stockbroker in Los Angeles, and immediately found a niche investing in small company stocks. In 1969 he was named as manager of a very small mutual fund and found success early on as an investment manager investing in microcap stocks; during one thirty month period in the 1970’s the fund’s net asset value grew by more than three hundred percent.  Fred decided to start First Wilshire Securities in 1977, and he would go on to have one of the best long term investment records with average annual returns of nearly 20 percent through the next three decades.  According to First Wilshire’s CEO Scott Hood, who shared portfolio management duties with Astman starting in 1998, Astman was “one of the best pure stock pickers that ever lived”. Here are the keys to how he achieved stellar returns.

Astman had a very methodical approach to finding attractive stocks. His search process often started by screening through the thousands of small cap and microcap companies listed in North America, looking for companies that met his criteria. He was a voracious reader and often got ideas from Value Line, the major business news publications like BusinessWeek, Forbes, Fortune, and The Wall Street Journal as well as Standard and Poor’s stock guides.  Once he found an interesting idea, he would often look at the competitors, which could often result in his buying other industry players if the whole industry was out of favor. Astman often looked for an interesting change in a company for a reason to buy. For instance, it might have been a change in management, a new acquisition, closing an unprofitable division, a change in product, or a change in direction in an overseas division.

He preferred to own stocks that were neglected by other investors and analysts.  Often, the companies that made their way into his portfolio were too small to be of interest to other institutional investors.  Astman invested in unpopular industries like direct selling (multi-level marketing) and payday loans. He would invest in companies that were headquartered in far off geographies like Hungary, China, Brazil or Guyana, where most investors were unwilling to tread. Companies on his buy list often had endured a recent industry cycle bottom.  For example, Astman loaded up on reinsurance companies after the extreme 2005 hurricane season had temporarily depressed the companies’ earnings. Around the same time, one-quarter of his portfolio was in Asian-American banks spread between six or seven of these banks.  Even though these bank stocks were trading at very attractive multiples of book value and earnings, and growing faster than their peers in the traditional banking sector with very little exposure to the overheated residential real-estate market, they were completely ignored by most investors. The common theme among all these stocks was that they were neglected by other investors and mispriced.

He liked to buy stocks with above average growth at below average multiples.  Growth was very important to Astman, and he believed that truly small companies held the greatest promise for growth.  He liked to buy companies that were growing earnings, cash flows and/or dividends at a minimum of 10-15 percent per year.  As important as growth was to Astman, he wanted to buy stocks at a Price/Earnings ratio of less than 10X current year’s earnings – the lower the better. He made numerous purchases of stocks over his career at a single digit earnings multiple, and some as low as 1X earnings. For example, in early 1989, he bought Kentucky Medical Insurance stock at $2.75 per share, when he projected they would earn $2.45 in earnings that year.  These early buys resulted in a sevenfold gain within twelve months when his earnings projections came through. That was a common theme among most of his stock picks – buying growing companies at below average earnings multiples.

Astman mitigated risk by insisting on certain qualitative and quantitative factors. He looked for companies with a sustainable competitive advantage who were industry leaders.  He wanted to see a solid balance sheet, preferably with more cash than debt, and conservative accounting methods. Companies with short operating histories were discarded and many of the companies he bought had been around for decades, which kept him out of more speculative sectors like technology and biotech.

He was a contrarian in how he bought stocks, and patient in building positions.  He liked to buy stocks well before other institutions started buying. Astman preferred to see no more than 5 percent  institutional ownership in the stocks that he was buying, and he would often start selling once  institutional investors like pension funds and small cap mutual funds got more involved in the stocks he owned.

Astman ran a relatively concentrated portfolio. The majority of his holdings were often in his top twenty to thirty stocks. He set a maximum position size at cost of 5 percent, and he was very disciplined about not chasing stocks that would move out of his buy range. He would mitigate risk by trimming holdings that would grow to above 10 percent of the portfolio, and he was not afraid to hold cash if he couldn’t find anything attractive to buy.   Despite being a great stock picker, he was humble enough to admit that one out of four of his picks would be losers, and he diversified accordingly.

Astman was a long-term investor.  He had a very low turnover of stocks in his portfolio and averaged about 25% turnover in any one year.  Despite thinking long term, he had a strong sell discipline, trimming stocks that became overvalued. However, if earnings and cash flows continued to grow in lockstep with the share price, he continued to hold, sometimes for as long as a decade.

He continued to follow sold stocks and would often recycle old names back into his portfolio. There were a number of stocks that showed up in his portfolio on and off over many years. He called these recycled stocks.  He would buy these stocks when they were out of favour and then sell them when optimism returned.  He continued to follow the stories, and he would often buy them back again the next time they went out of favor.  These recycled stocks often comprised 10-20 percent of his stock purchases. Nature’s Sunshine was one such stock that showed up in his portfolio on and off over nearly 25 years.

Astman preferred a team approach to investment analysis.  Over the years, he grew First Wilshire Securities from a one man shop to several analysts and two portfolio managers. He attracted like-minded investment professionals who shared his investment philosophy. He mentored and trained his analysts as generalists, and allowed them to pursue their research wherever it needed to go. Astman guided the investment philosophy of the investment firm, but he felt that taking a team approach resulted in better analysis, and they could cover more companies.

He had a meticulous process for evaluating management. He and his team of analysts would often visit management at their company headquarters, which would often give them clues about how the company was running. He evaluated management based on whether or not they had skin in the game through stock ownership, and whether they were taking an excessive amount of stock options. He was interested in evaluating the CEO but also looked at the history of the other management team members. He also sized up the board to see if they were autonomous.  In addition, he evaluated whether management was reporting their numbers on time or not.  Astman and his team performed ongoing research to keep up to date on companies.

Astman made an effort to attract long term investors as clients. He wasn’t interested in accepting short term money because he knew that there would be temporary periods of underperformance. However, he was confident that over three to five year periods, his performance would be satisfactory and his clients would do well if they stuck with him.  And quite well they did do. If a client had invested  $10,000 with Astman when he first put out his shingle in 1977, over a 30 year period it would have compounded to roughly $2.7 million at a 20% annual growth rate.

Astman had a passion for stock picking and shared the rewards of his success.  At 82 years old, he was still going into the office for twelve hour days, six days a week, and at 90 years old still showed up five days a week.  He was very generous with his time, mentoring not only his analysts, but also met with up and coming money managers who made the trek to visit Astman in Pasadena, California to seek his council. He was also very generous in his philanthropy. He and his wife Jean set up a foundation that focused on helping children locally and globally and did it in a way that was under the radar.

On April 2, 2013, at the age of 90, Fred Astman passed away.  Even though he had no children of his own, his legacy is carried on through the charitable foundation he and his wife started, as well as the investment family that he left behind at First Wilshire Securities. For those of us who never had the chance to meet him, but are willing to study his investment process, Astman laid out a framework that investors could use to achieve enormous success investing in small companies. Fred Astman left this world as one of the best stock pickers that ever lived and I, for one, am a better investor for having studied him.

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About the Author

Chip Maloney

Chip Maloney is a Canadian-based private investor and has been investing primarily in non-resource Canadian microcaps for 15 years. His investment style could be summed up as GULP (Growth at an Ultra Low Price). When he is not doing investment-related reading, you can find him running, biking, skiing or spending time with his wife and daughter.

Comments 17

  1. Thanks for that interesting profile Chip. It brings up a question I’ve been struggling with, and one I think that is fundamental to investing — how much to pay for desirable characteristics — profitability, growth.

    Like with racehorses you can make or lose money paying $10 million or $10,000 per animal, but your odds, your risk/reward ratio, may be more in your favor at $10 million than at $10,000. Or you can specialize in horses that when healthy tend to win races, but that often have tendinitis or other ailments.

    If you have two companies, one growing at 100% a year and selling for fifty times earnings, and one growing at 10% a year and selling at 10 times earnings, which one offers the better value? There are many nuances and considerations — for instance how much of the fifty times earnings company’s earnings are recurring and what percentage of those earnings need to be replaced every year — balance sheet condition etc. But in general a group of companies growing 100% a year is, in my mind, the better value with an average P/E of 50, although there may be a number of failures in both groups.

    Not that there’s anything wrong with investing in good companies growing at 10-15% a year at reasonable prices — the Astman strategy is obviously very valid and proven. So is investing in the fastest growing companies in America at relatively high prices. The latter strategy is riskier, and results in more volatile returns. If one loves investing, loves the challenge, wants to become a master of investing, is willing to obsess over the nuances, thinks he or she has in place a system to control risk, investing in $10 million racehorses has much to recommend it.

    The race is not always to the swift nor the battle to the strong, but that’s the way to bet.
    ~Hugh E. Keough

    It is a matter, mostly, I think of personal preference. And skill, and patience — a willingness to obsess over the nuances, and the judgment to discern which facts, which nuances, are relevant even crucial, and which can be dismissed as irrelevant or of minor impact. That’s an exciting challenge to me — finding the next Apple by studying the nuances of history, and trying to find another company to which they apply. And what is a reasonable price and what is too much. And what to do when it’s down 10% or down 50%. That’s an exciting, fascinating way to spend one’s investing career.

    On the other hand, Mr. Astman would probably think that is too risky to be fun, and that finding a diamond in the rough is the more satisfying way, deeply enjoyable way, to spend one’s investing career.

    There are many fascinating ways to skin the investing cat. And many ways to lose money.

  2. Thanks for the comment Rod. That is a great question that we as investors can spend a lifetime answering – what should we pay for the desirable characteristics that we crave as investors – profitability, growth etc.?

    I think Astman and First Wilshire’s approach is pretty low risk. If you are buying growing companies at single digit earnings multiples, it doesn’t usually take too long for the market to wake up to the value as long as earnings continue to grow. I have invested in high growth/higher multiple stocks and low growth, low-multiple stocks and had blow-ups in both. I think one’s certainty about future growth in earnings/cash flows has to be much stronger in the high multiple stocks because, in my experience at least, when earnings growth slows, the market reacts less severely in low P/E stocks, but not always.

    There are dozens of fast growing, high ROE, high P/E multiple stocks that I have missed that I was unwilling to pay up for that have gone on to become ten or twenty baggers and more. The longer I invest, the more I am willing to pay up for and hold truly great companies at higher multiples. The trick is trying to avoid stocks where you thought you were investing in a great company but “surprise” it turns out it’s the complete opposite.

  3. i got to know fred nearly 40 years ago when he was running a fund. it was one of the coldest years on record and he mentioned diamond chrystal salt to me. it was a very big winner for me / had been a big follower of fred since then. he taught me a lot about small cap value investing. he loved his job and died from a fall at an investment conference which fred would have probably said, “if i gotta go, this is the way i want to go”.

  4. Thanks very much for the comment Buzz. I did not know that’s how Fred passed away – very tragic, but as you say how many people get to do what they had a passion for right until the end. I would love to hear any stories that stand out about Fred or any specific lessons Fred taught you if you are willing to share.

  5. Great article as usual, Chip. The comments are great too. It’s interesting to consider the similarities and differences of the great investors. I read your article and some of Astman’s qualities reminded me of Lynch (fast growers, “methodical process” aka the checklist, catalysts, recycling stocks) and Neff (low P/E, out of favor stock picks). Of course Neff and Lynch were limited by the size of Vanguard Windsor and Fidelity Magellan, respectively.

    I personally find the 10x current earnings benchmark to be difficult; I wonder whether in this low interest rate world this would lead to a portfolio of value traps or companies just emerging from turnaround situations or even worse, cyclicals at cycle highs.

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      Thanks for the comment EightTrack. I think it’s definitely tougher to find attractive low P/E stocks that are not value traps or cyclicals in this low interest rate environment. First Wilshire has done pretty good at finding investments that fit their criteria over the last decade – as of last year they had a net annualized return of 16.8% over the previous 15 years vs. 7.4% for the Russell 2000. I’m not sure how they’ve done in the last year. It’s probably gotten harder to find qualifying investments as their AUM has increased and they have had to move into higher market cap stocks. I think about 1/4 of the stocks First Wilshire has historically bought are turnarounds or just dirt cheap stocks on a liquidation value basis or net-nets or something along those lines.

      I think if Astman were still alive and managing a small amount of money, I think he would be able to find 20 investments meeting his criteria. They may not all be in North America, but he could probably do it.

  6. I really enjoyed this article. I think maybe all of us have crossed paths with our own personal Fred Astman at some point. A true professional who just goes about their business. Thanks for the Great read!

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      Shaindy,
      Not sure about any asset managers in the U.S. but First Wilshire Securities still invests with the same philosophy as when Fred Astman was still alive and has a very good track record.

      I know a number of private investors who invest in a similar way to Astman, but they only manage their own investments.

      I am Canadian-based and there’s an investment firm in Canada named Hesperian Capital who runs the Norrep Funds. Randy Oliver used to run the funds many years ago and had a long record of 20% plus annual returns for many years using a similar strategy of paying below market P/E multiples for above average growth and high ROE. The Mawer New Canada Fund and Donville Kent Asset Management, also based in Canada has a GARP approach that both have very good records, although DKAM is not as long of a track record.

  7. Hey Chip. Great article. So I got a very specific question about microcaps. Some of these companies are so small that they don’t have enough money to segregate departments and they usually report deficiency in internal controls. This is especially true for companies under 20 million market cap. Are you ok investing in companies with deficient internal controls?

  8. Will,
    Thanks for the comment. I invest almost exclusively in the Canadian market and haven’t noticed deficiency in internal controls to be a big problem in Canadian microcaps although I do recall some cases . Maybe it is a more common occurrence in the OTC market, but that is out of my area. I am not an accountant/auditor, but a deficiency would probably be at least a yellow flag for me, and if it were something I didn’t already own, I would probably pass on the idea pretty quick.

  9. Nice article thought provoking. Which are the long term performing funds or mutual funds in small cap. In Canada?names?

  10. Great article. I have been an investor in First Wilshire since 1990 and finally got to meet Fred in 2010. He was engaging and humble. I was able to retire very young thanks to Fred, Scott and their team at FWSM.

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