High Conviction

There is a massive difference between taking a large initial position and allowing a position to become large. Few investors understand this distinction.

Taking a large initial "at-cost" position is the investment equivalent of getting married after one date. In contrast, building conviction in a management team and business is like building trust in a relationship. It can’t be rushed. Trust is built at the beat of its own drum. Every position is unique, just like every relationship is unique, and conviction scales differently with each investment.

One of the most rewarding aspects of stock picking over 20+ years is looking back to see how I've evolved. The thousands of buy, sell and hold decisions. Some ultimately impact you far greater than others. Every investment decision shapes the next version of you like a sculptor shapes a piece of art, and knowing which specific experiences changed your perspective is invaluable.

Growing Means Evolving

I have always been a conviction investor, but I have evolved in how I define "high conviction" and how it is expressed within my portfolio. When most investors hear high conviction, they think of high concentration. To them, concentration means making massive bets. Specifically, initial position sizes of 10% or more. 

Most investors operate under this logic:

High Conviction = High Concentration = Large Initial Position Sizes

I used to believe this too, but I now realize this thinking is flawed. Conviction investing is a deeply personal pursuit where subjectivity blends with objectivity. To an outsider, true conviction often looks like stubbornness or even arrogance.

What is Conviction?

Conviction is when you KNOW a business or a stock better than most other investors in that name.

Notice that my definition does not include hoping or believing more than others. Those are emotions, and they are rarely grounded in facts. You don’t build conviction by waiting for management to tell you how the business is doing, nor do you build it by doing what the average investor does while hoping for an above-average outcome.

True conviction means understanding the Key Performance Indicators (KPIs) that drive the business and finding ways to track them independently of management’s commentary. This requires "scuttlebutt," channel checks, and expert calls. It often means digging for exclusive public information that isn’t readily available to those who aren’t looking for it.

High Conviction ≠ No Risk

High conviction does not mean all risk has been eliminated. The higher the valuation, the higher the risk. In addition, variables outside of a company’s control which may impact your ability to "know" a business better than others also increases risk.

Every business in a portfolio is susceptible to different risks and magnitudes of risk. The fund I manage invests in various microcap business types, ranging from "story stocks" with no revenue, to growth stocks with no profit, to GARP stocks with growing revenue and profit. We are industry agnostic, owning healthcare, exploration and mining, oil & gas, cybersecurity, building material retailers, cannabis, infrastructure, and aerospace and defense. The common thread across all these positions is my perception of quality management.

Because each industry and business type has its own risk profile, high conviction isn't "cookie-cutter". It doesn't mean every situation warrants a 5%, 10%, or 15% at-cost position. High conviction might justify a 3% position in one instance and 8% in another. Initial sizing should be based on the adjusted risk profile and the upside/downside ratio.

Upside, Downside, and Liquidity

The upside of a company is the gap between today’s valuation and what you believe it will be worth in 2-3 years. This is often difficult to assess, as it is a combination of fundamental execution, the "story," and whether macro conditions are acting as a headwind or tailwind to valuation multiples. It is always best to remain conservative with future expectations.

Here is the funny thing about microcaps and downside. No matter how cheap or undiscovered you think a microcap is, EVERY microcap has 50% downside. When you are calculating upside to downside ratios across your portfolio and watchlist, the starting point is down 50%.

If you manage large sums, initial sizing may also be a function of liquidity. It might take me a week or three months to build a 3% position. I don't avoid a stock just because it might "get away" from me before I reach my target size. IRR is IRR whether it's a 1% or 3% position, and with patience, I can usually acquire the desired stake.

A Stock Picker is a Chef

Envision you are a Chef hosting a dinner. Mise en place is the French term for having all ingredients measured, chopped, and arranged before cooking. Your guests haven't been told what you are making. They only see the raw ingredients on the counter. A few guests become concerned because they see an ingredient they personally dislike.

However, you have made this dish a hundred times. It’s a favorite of yours. You’ve also put your personal mark on it with a pinch of this or a drizzle of that. The guests watch you incorporate the ingredients in specific ways and precise quantities. They may remain skeptical until they finally taste the dish and realize it is delicious.

In the same way, outside investors might be skeptical of your portfolio’s ingredients and weightings. They have preconceived notions based on their own experiences, or lack thereof, with a specific industry. They see a standalone ingredient rather than a piece of a larger flavor profile. 

I’ve jokingly referred to my portfolio like a stew. To outsiders the ingredients don’t make sense, and the dish looks like a pile of slop, but it sure tastes good. 

Using Unloved Ingredients 

The investment world is full of contradictions. For example, many investors avoid "price takers", businesses like oil & gas, or resources or even cannabis where the market decides the price of the commodity.

However, if you invert this negative attribute, you find a positive. Some of these companies often don't need sales or marketing departments. They simply need to produce at a cost lower than the market price. You are trading pricing power for the insatiable demand that is always present at a certain price point.

More importantly, it is easier to spot great leadership in these "awful" industries. When a sector is contracting, the outliers that remain profitable and continue to grow become obvious. Identifying these companies at cyclical lows can create generational wealth.

The risk here is unknowable duration risk. You might have to wait 2-3-5-10 years to make 2,000% in 18-months. The equities in these industries can remain dormant for years due to capital outflows. You express this unknown through smaller position sizing. I can have high conviction and still hold a small position. A position size that allows me to stay the course financially and emotionally until the destination is reached.

I also hold a couple story stocks. The main risk is dilution. I might love the story, and the management. Perhaps the management team even had previous success, but past success doesn’t guarantee future success.

Story stocks have heightened macro and stock market sensitivity. In a bull market a story stock might trade at a $200 million valuation. In a bear market that same story stock might trade at a $10 million valuation. Same story. Different valuation. I may have high conviction in a story stock, but these risks get reflected in smaller initial position sizing. 

High Conviction ≠ High Concentration ≠ Big Initial Positions

I hold a concentrated 15-stock portfolio where my top four positions are each 10% or more. All of them began as 2-4% at-cost positions.

High concentration doesn't mean sizing big in the beginning. It means letting winning positions get big in the end. 

A position earns the right to be large by going up 3x, 4x, 5x+. It is much easier to sleep at night during volatility when you’ve already been proven right and the position has earned its larger weighting. 

Many mistakes stem from oversizing and overstepping your conviction at the exact moment you are most excited about a company – at the beginning of the relationship when euphoria is at its peak. 

Gavin Baker, Managing Partner/CIO of Atreidas Management said it best, “Take your time getting to know the people and only make a very large bet once you have a history with the management and the company.” 

Building a big position in the portfolio is the same as building trust in a relationship. It can't be rushed. You must experience firsthand how the management and business will react in good and bad times and how they treat you. Let the position earn its scale.

_{MicroCapClub is an exclusive forum for experienced microcap investors to share and discuss microcap companies (sub $1 billion market cap) trading on global markets. Since 2011, our members have profiled 1400+ microcap companies, 300+ have turned into multi-baggers. Investors can join our community by applying to become a member or subscribing to gain instant access. For more information, visit https://microcapclub.com/}