Research has been done over the years which has shown small and microcap value stocks outperform the general market. When filtering out the poorest of the bunch and factoring for value/growth/momentum the outperformance is much greater (A report from OSAM.com shows quality adjusted microcap stocks returned 14.2% annual from 1982 to 2016). With this in mind I decided recently that a perfect portfolio would consist of about 20 to 25 microcap stocks in varying industries, where quality counts, and other metrics like liquidity or analyst coverage has no bearing on whether or not a stock is included (I mention these last two things because most portfolio managers would cringe at low volume/illiquid shares or companies with no analyst coverage whatsoever - and this is precisely the edge). While I have been researching loads of stocks to include in the portfolio I have been thinking about the dynamics of gathering positions and market/cycle timing. Microcaps are even more cyclical than the general market so thinking about where we are in the economic cycle will play heavy on the performance of the portfolio and the timing of share purchases. I am assuming we are very late in this economic cycle and barring any more rabbits pulled from the Fed’s hat or more sugar rush kicks (like the enormous tax cut package) which I basically consider can-kicking to extend the cycle, I believe that a good amount of cash should be deployed only when a recession is fairly evident and a bear market is observed. So with that said (and knowing how difficult market and cycle timing can be) I will most likely build positions over a very long time frame, such as the next 2 to 3 years, meaning the first batch of purchases of the 20 to 25 identified positions should amount to only about 15% of total cash outlay and the rest of the portfolio’s capital deployed slowly but opportunistically using deep low-ball good-til-cancel orders which would get filled on big market down days - or when an impatient investor decides to unload stock at any given time - which is precisely why I like illiquid/wide spread shares. Also, since this portfolio will most likely have a fixed amount of cash to start with little being added later to invest, dividends will play an important role in purchasing future shares. With that said, while probably only half the companies I have researched so far provide a dividend, those that do have an average yield of about 4% which will be reinvested. Also, while buy and hold will be the goal, there will be some churn which will also provide liquidity for future purchases (just like opportunistic purchases, opportunistic sales will happen during periods of volume and price spikes, etc). While there are no strict metrics for what is considered value in this portfolio, the average company will have no or little debt, lots of cash, P/E ratio (dependent of industry) but typically 15 to 25 with some growth. Small companies can be very lumpy with hit or miss quarters, so in the short term some patience is necessary, as long as longer term company or sector specific trends do not stray too far from the course. I will update more specifics soon.
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Paul SaadSenior Manager, Paul Saad and Associates, LLC Archives
May 2020
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