(Image: Zen Buddha Silence by Marilyn Barbone.)
February 26, 2017
Are you a long-term investor? If so, are you interested in maximizing long-term results without taking undue risk?
Warren Buffett, arguably the best investor ever, has repeatedly said that most people should invest in a low-cost broad market index fund. Such an index fund will allow you to do better than at least 90% of all investors, net of costs, after several decades.
Buffett has also said that you can do better than an index fund by investing in microcap stocks – as long as you have a sound method. Take a look at this summary of the CRSP Decile-Based Size and Return Data from 1927 to 2015:
|Decile||Market Cap-Weighted Returns||Equal Weighted Returns||Number of Firms (year-end 2015)||Mean Firm Size (in millions)|
(CRSP is the Center for Research in Security Prices at the University of Chicago. You can find the data for various deciles here: http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html)
The smallest two deciles – 9+10 – comprise microcap stocks, which typically are stocks with market caps below $500 million. What stands out is the equal weighted returns of the 9th and 10th size deciles from 1927 to 2015:
Microcap equal weighted returns = 16.14% per year
Large-cap equal weighted returns = ~11% per year
In practice, the annual returns from microcap stocks will be 1-2% lower because of the difficulty (due to illiquidity) of entering and exiting positions. So we should say that an equal weighted microcap approach has returned 14% per year from 1927 to 2015, versus 11% per year for an equal weighted large-cap approach.
Still, if you can do 3% better per year than the S&P 500 Index (on average) – even with only a part of your total portfolio – that really adds up after a couple of decades.
- Most professional investors ignore micro caps as too small for their portfolios. This causes many micro caps to get very cheap. And that’s why an equal weighted strategy – applied to micro caps – tends to work well.
VALUE SCREEN: +2-3%
By adding a value screen – e.g., low EV/EBIT or low P/E – to a microcap strategy, it is possible to add 2-3% per year. If you would like to maximize the odds of achieving this additional margin of outperformance, then you should adopt a systematic, quantitative investment strategy.
IMPROVING FUNDAMENTALS: +2-3%
You can further boost performance by screening for improving fundamentals. One excellent way to do this is using the Piotroski F_Score, which works best for cheap micro caps. See: http://boolefund.com/joseph-piotroski-value-investing/
In sum, over the course of several decades, a systematic value strategy – applied to cheap microcap stocks with improving fundamentals – has high odds of returning at least 7% (+/- 3%) more per year than a low-cost S&P 500 Index fund.
BOOLE MICROCAP FUND
An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time.
This outperformance increases significantly by focusing on cheap micro caps. Performance can be further boosted by isolating cheap microcap companies that show improving fundamentals. We rank microcap stocks based on these and similar criteria.
There are roughly 10-20 positions in the portfolio. The size of each position is determined by its rank. Typically the largest position is 15-20% (at cost), while the average position is 8-10% (at cost). Positions are held for 3 to 5 years unless a stock approaches intrinsic value sooner or an error has been discovered.
The mission of the Boole Fund is to outperform the S&P 500 Index by at least 5% per year (net of fees) over 5-year periods. We also aim to outpace the Russell Microcap Index by at least 2% per year (net). The Boole Fund has low fees.
If you are interested in finding out more, please e-mail me or leave a comment.
My e-mail: firstname.lastname@example.org
Disclosures: Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. This material is distributed for informational purposes only. Forecasts, estimates, and certain information contained herein should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of Boole Capital, LLC.