Buy And Verify

Ian Cassel Blog, Educational 4 Comments

The “Coffee Can Portfolio” approach to investing might work for larger companies, but it’s the surest way to go broke in small microcap companies. Small microcaps evolve in different ways, and a lot of the ways aren’t good ways. You can’t buy and forget, you need to buy and verify, and the smaller the company the more often you verify.

Microcaps are like three year old children. They can be totally unpredictable. One moment they are cuddling with you on the couch and the next minute they are trying to burn your house down. It’s why you have to watch your microcaps like you watch your small children. Closely.

Due diligence doesn’t end with your purchase of a stock. It is just beginning. Your initial due diligence might get you invested but it’s your maintenance due diligence that will keep you invested. Especially with microcaps, don’t take your eye off of them. Situations can change in an instant. Know what you own at all times.

We all want to compound capital at high rates. Time and interest are the primary components of the power of compounding. Over a lifetime you will likely own 10-20 big winners and hundreds of losers. Your future returns will be decided by how well you can hold onto the handful of winners while cutting the plethora of losers. Losers are a waste of your time.  I’m still a full-time investor today not because of my gains, but because of the losses I didn’t take. A big part of investment success is identifying the losers quicker. 

When you know a company really well you can almost feel the pulse of the company. It has a rhythm. And you can feel when it changes. How do you find the pulse? 

Study the Market 

Understand the tailwinds or themes that are pushing demand. Will it continue? For how Long? What could disrupt it? How are things evolving? e.g. smaller, faster, cheaper, more transparent, etc. Subscribe to trade journals or industry publications. Set up Google Alerts for key phrases and news. 

Study the Customers

Why would they choose one company over another? Is it price, service, features? What type of customer best fits the company you are looking to invest in? How many competitors are in that subset of customers and does your company really have the best solution? 

Study the Competitors 

Understand the competitive landscape and how each of the major players differentiates themselves. If competitors are public companies, study their financials and listen to their conference calls.  Follow the competitive news flow. If they are private competitors – Are they growing? Are they hiring? How do job openings compare to 6 months ago, 1-2 years ago?  Keep a look out for anything disruptive. Even if it’s just optical disruption (not literal) it can make an impact on perception and stock price. 

Study the Company and Culture

Great companies have happy customers and happy employees. Talk to management and a few people right below the C-Suite. Talk to a salesperson or two at the company. Ask them what would allow them to sell more? Talk to lower level employees to gauge the culture.  Talk to people. Talk to people. Talk to people. Form relationships so you can check in from time to time. 

The only thing more important than having a great investment thesis is knowing what will kill your investment thesis and having the decisiveness to act.

As you study the business write down a list of things, actions, events, that would impact your investment thesis. You should rank them by severity. When appropriate and in the right way, go over the list with management to get their thoughts. You might learn from them that some of the items on the list are more or less important than you originally thought. This list will likely evolve the longer you own an investment. Some items will move up or down the list or drop off completely while other items will be added. 

When you do the work you find the pulse of the company. You then need to check the pulse regularly and verify all the areas we outlined above to watch for any sudden changes. The key is identifying these things before the rest of the market. Keep that list of potential thesis killers front and center.

You are looking for external and internal tells. An external tell is when something outside of the company has changed. An internal tell is when something inside the company has changed which could impact your thesis. 

The other day I tweeted my top three biggest investing mistakes.

There have been several occasions where I did the work and could feel the pulse of the company change for the worse but didn’t sell. 100% of the time it was a mistake not to sell. In some of these instances I had anchored my ego to the position. When the facts and story change don’t let your ego get in the way of selling. 

All successful investors have two things in common. They are extremely disciplined and they understand the downside of their investments even more than the upside. A big part of winning big is only losing small.  

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Comments 4

  1. Thanks Ian,

    Ego is the biggest enemy we face. There were so many times I knew or felt that an investment thesis ddin’t hold up but I was in denial or tried to justify it. Mainstream investors aim to buy and hold forever. With micro/nano caps the goal is not to “nurse a loser” when you should let it go.

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      Thanks Mike. It’s often times hardest to shed a loser because it’s easier to form our highest convictions in our losers because we are constantly justifying owning them. If the business is growing and earnings more money but the stock isn’t working it’s good to hold, but if you are waiting and waiting and waiting for “the catalyst” in a cash burning company it is normally a painful ride down.

  2. Great article as usual, Ian.

    Every active investor I know owns a slug of HUBR. Every. Single. One.

    The question is, how big a position is HUBR (Hubris, Inc.)? Your #10 position? Your largest position?

    I shudder at the memory of past decisions when I sold a winner to double up or triple up in HUBR. Somehow HUBR always fails to outperform the market … the perpetual falling knife 😉

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