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September 20, 2021

A Microcap Stock Picker’s Market Learn Why This is Our Favorite Kind of Market to Operate In

How has your portfolio performed in 2021? If your portfolio was like ours, it’s been tough.

Liquidity for Canadian microcap companies has dried up, and with retail and institutional investors focused on eliminating liquidity risk by shifting their portfolios into more liquid, higher market cap stocks – it’s left illiquid microcaps in the dirt.

In a previous article, near the top of the recent bull market in microcaps, we highlighted our observations on the frothiness of the market in smaller stocks which can be read here: https://tinyurl.com/w6pfx3ye

 

Carnage in the Microcap Market – Creates Opportunity.

While 2020 was an exceptional year and one of the best we have ever had, the TSX-Venture index peaked in February 2021 at roughly 1,100. And since then, investor confidence has fizzled, and investor participation has disappeared.

We will let the TSX-Venture index speak for itself, but it’s clear that since February 2021, the market has been in a long, boring, and protracted down-trend.

Why is This Our Favorite Type of Market to Operate in?

We feel the current market dynamics are the optimal environment for microcap investors with a long-term time horizon. However, we also recognize that this market has been psychologically challenging and emotionally draining. It’s evident that over the past nine to twelve months microcaps have been lackluster with poor performance and very little investor enthusiasm. Nonetheless, as contrarians, we believe these conditions are necessary for superior returns.We believe we are in a microcap market where boredom, panic selling, and extreme investor pessimism has passed. While there are no institutional buyers, and still more 52-week lows than 52-week highs, we believe most of the exhausted investors have capitulated. What makes us even more excited is that this is happening in the face of strong fundamental performance from the many microcaps we monitor.

This is our favorite type of market to operate in. As we often like to say we like to instead of the old “Buy when there is blood in the streets” we prefer: “Buy when there is no one in the streets”

The combination of dropping share prices and improving fundamentals is producing the perfect storm. After a year of bludgeoning, valuations in select microcap stocks have become or are becoming cheap. Not only are we finding discounts, but cheap valuations on high-growth companies – which we believe is an even greater mispricing opportunity.

We say it’s our favorite market to operate in because, when stocks are this cheap you want to be a buyer. And most importantly, you want to buy in size. Furthermore, given the lagging market sentiment, the late to the party sellers are readily capitulating their shares for the opportunistic investor.

This rare combination allows investors to get both a discount and supply – aptly positioning them as the tides turn. For the retail investor, which we also fit in that category, this is the best type of market to operate in. We have much less liquidity or size constraints and can maximize our opportunity by our extended time horizon – It’s a buyer’s market.

Patience is one of the Hardest Skills to Master

Not long ago it was hard to buy stock – offers were thin and stocks were ripping higher.

Conversely, in this market, it’s hard to sell stock – There are limited bids, large illiquid spreads, and other sellers competing as stocks sink lower.

One of the hardest skills for investors to master is patience. We all wanted to be rich…. yesterday. As a reaction to these biases, we often think being more active will lead to a greater result.

As market sentiment shifts, like a pendulum, from bear to bull, a big challenge will be holding on to your positions, especially after a long drought of not making any profits. Psychologically, it’s easy to want to take the quick profits, but is that the right move right now?

Don’t be flipping pennies for dimes or dollars.

Following the herd and selling stocks after a down-market isn’t contrarian. Buying and owning stocks, while and after, sellers have capitulated is contrarian – knowing that the big money is on the sidelines means there’s a future opportunity for higher share prices. One of the most expensive mistakes investors make is selling great companies at the wrong time and too early.

We caution our readers to be mindful of these lessons we are sharing, as we sense momentum in the microcap market is shifting.

Cheapies With a Chance

Every year, we review SEDAR filings alphabetically (and sometimes in reverse if we’re feeling crazy) from top to bottom searching for high-growth companies with crazy cheap valuations. It’s a list we share with our paying subscribers that we call the Cheapies with a Chance.

Our process involves manually scanning the financial statements seeking companies that are growing at a minimum of 25% or have other compelling fundamental mispricing’s. After compiling this list, we continue to diligence each of the companies and try and select a top ten list of the companies that we think offer the most compelling opportunity.

The results over the years have been astonishing. Take for example our list from this year, which we released mid-January. Despite the challenging year, if you had purchased all 10x stocks, the portfolio would be up 59% year to date. We consider ourselves stock-pickers, and every year we release what seems like an obvious strategy to generate a consistent return, we remind ourselves we cannot time a market and should just buy what we think is cheap – The Cheapies with a Chance list has just reminded us again.

Considering how poorly the microcap market has performed this year, we thought it was an ideal time to research and share a new list of high-growth/mispriced opportunities. We have compiled our list and are close to releasing the Cheapies with a Chance list – We can’t wait to share them with you, and discuss the ideas on a Free-For-All!