Always Be Thinking Ahead

In 2020, many of us outperformed. But to be honest — 2020 was a year that made most of us look a lot smarter than we are. All you had to do was own some technology stocks, not sell them, and you were up 50%+. Apple (AAPL), the largest public company in the world, was up 80% in 2020. Amazon (AMZN), the second largest public company in the world, was up 76%. Tesla (TSLA) was up 740%. I communicated to my IFCM investors in my Q4 Letter, “We don’t want to downplay our accomplishments, but truth be told we aren’t sitting around hand slapping and grab-assing about the past. We are focused on the future and this is where we will spend the remainder of this letter.”

“Make your portfolio reflect your best vision for our future. Always be thinking ahead. Be optimistic. Think about the world that you want to create, because sure enough your dollars and mine, our capital, is helping shape the world.” 

– David Gardner, Co-Founder, The Motley Fool 

David Gardner spoke at our virtual MicroCapClub event this past September. His optimism and enthusiasm were quite apparent when he talked about his portfolio and strategy. It made me evolve my thinking in some ways. In the past I’ve invested in some good businesses with good fundamentals, but I didn’t connect with the product or service. Naturally I would focus too much on the quarterly financials because that’s why I was investing in them….for the next set of numbers. I’ve concluded these types of investments are a distraction. 

If you aren’t excited about the future, you are in the wrong investments. You need to own investments whose mission, management, and products/services excite and energize you. Why? It’s the only way you will be able to hold them. I’ve added this concept as an overarching filter to my diligence process. I exited a couple positions in 2020 that didn’t meet this standard. 

To achieve a multi-bagger in the portfolio, you have to hold a multi-bagger in the portfolio. Holding can be excruciating. Especially winners. I know it’s hard to believe given the market conditions so far in 2021, but my largest position is down 40% since the beginning of the year. Nothing has changed with the business, it’s the normal ebbs and flows of holding a winner. 

Here is what a multi-bagger looks like over several years: 

$1 – $2 – $2 – $3 – $2 – $3 – $4 – $6 – $6 – $12

$1 to $12 in 10 years. This is a 28% compounded annual growth rate (CAGR). This is a phenomenal return. Investors love to consolidate success down to one number. The bad thing about representing growth as a CAGR is it smooths out the volatility and pain to achieve it. High CAGRs aren’t smooth linear lines ascending to heaven. They are rollercoasters. 

You will have to hold while the stock doubles in a year. You will have to hold as the stock pulls back 50% from its highs. You will have to hold as the stock goes nowhere for months, quarters, maybe years, as fundamentals backfill into a higher stock price. You will have to hold as expectations get too high or management goes through growing pains. You will have to hold as the stock is cheap and expensive. You will have to hold while the stock is loved and hated by other investors. 

Through this war of emotions and volatility you still need to determine which companies deserve to be held. Portfolio turnover is the price of progress. In many ways microcap investing is like trying to find future NFL quarterbacks while they are still in high school. It’s a tough business, but it isn’t impossible. You can spot high integrity talent even at a young age. You won’t be right all the time. But you have to be willing to make smaller bets and follow their progress. If they develop in the right ways, you buy more. If they evolve in the wrong ways, you sell and move on. 

We play a game of slugging percentage, not batting average. The institutional agenda is to never be wrong (batting average) instead of focusing on power laws (slugging percentage). It’s why everyone and their brother is a “compounder investor”. It sounds good and you won’t look dumb at cocktail parties. But the perfect stock today often times looked imperfect in the past. You have to take on a little risk (You might look wrong!) to hit the big ones – so size them accordingly.

“Show me a guy who’s afraid to look bad, and I’ll show you a guy you can beat every time.” 

– Lou Brock

“It’s not whether you’re right or wrong, but how much money you make when you’re right and how much you lose when you’re wrong.” 

– George Soros 

One of my investors recently asked me: What does a successful microcap portfolio look like in 5-10 years? A successful microcap portfolio should look “bigger”. We aren’t going to sell out of our winners just because they’ve grown into smallcaps — that sounds like madness. The key to outperformance is to hold your winners as long as you can. I would hope we are holding a few $500m to $2 billion market cap companies in the portfolio. I’d also expect us to hold a few more positions. As we slowly sell a little bit of our winners/ veterans we’ll redeploy into some rookies. Success would be a deeper bench with some $40 million market cap rookies sitting beside some of our $1 billion market cap winners/veterans.

As microcap investors we always need to be thinking ahead, but not too far. 

“Go as far as you can see; when you get there, you’ll be able to see farther.” 

– J.P. Morgan 

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