The Shiller P/E—also called the 10-year P/E or the cyclically adjusted P/E (CAPE)—recently exceeded 38. This is in the top 0.5% of history. The CAPE has only been higher one time—December 1999, when it reached 44.
However, according to John Hussman’s most reliable P/E ratio, the S&P 500 index today is at its most overvalued level ever, including December 1999. John Hussman writes:
MarketCap/GVA is the ratio of the market capitalization of nonfinancial companies to gross value-added, including our estimate of foreign revenues, and is our most reliable gauge of market valuation (based on correlation with actual, subsequent 10-12 year S&P 500 total returns in market cycles across history). The current level of 3.3 is the highest extreme in history, eclipsing both the 1929 and 2000 bubble peaks.
The long-term average CAPE for the S&P 500 index is 17. But even if we assume that the CAPE should be 20, that is still 47% lower than today’s CAPE of 38.
So the CAPE is likely to decline to somewhere in the range of 20 to 22. This means that the S&P 500 index is likely to decline 40% to 50% over the next 3 to 5 years.
Warren Buffett, arguably the greatest investor of all time, has raised $325 billion in cash at Berkshire Hathaway. So Buffett clearly thinks that market is overvalued. In fact, Buffett says that total market cap to GNP is “probably the best single measure of where valuations stand at any given moment.” Currently, the total market cap to GNP is 201%, one of its highest levels in history, comparable to December 1999.
When did Buffett last have so much cash as a percentage of Berkshire’s portfolio?
2007 before the Great Financial Crisis
1999-2000 before the internet bubble popped
INFLATION MAY PICK UP AGAIN
The consumer price index (CPI), which measures price growth across a basket of goods, ticked up to an annual pace of 2.6% in October – from 2.4% in September, which had been the slowest rate in more than three years.
Importantly, the 10-year treasury yield has increased from a recent September low of 3.649% to 4.445%. The great macro investor Stanley Druckenmiller said just recently he trusts market prices more than he trusts professors. The 10-year treasury is predicting that inflation will start increasing again, forcing the Fed to stop lowering rates and possibly to start raising rates.
If, in fact, inflation keeps increasing and the Fed has to keep rates high, that would probably be a catalyst for the S&P 500 index to start a 40% to 50% decline over the next 3 to 5 years.
That said, the catalyst for a bear market could be any number of things, including inflation inceasing, a possible recession, or something else the market is not currently considering.
BUBBLE HISTORIAN JEREMYGRANTHAM
As bubble historian Jeremy Grantham notes, there has never been a sustained rally starting from a 38 Shiller P/E. The only bull markets that continued up from levels like this were the last 18 months in Japan 1989 and the U.S. tech bubble of 1998 and 1999. Both of those great bubbles broke spectacularly. Separately, there has also never been a sustained rally starting from full employment.
What happened to the 2021 bubble? It appeared to be bursting conventionally in 2022—in the first half of 2022 the S&P declined more than any first half since 1939 when Europe was entering World War II. As Grantham points out, previously in 2021, the market displayed all the classic signs of a bubble peaking: extreme investor euphoria; a rush to IPO and SPAC; and highly volatile speculative leaders beginning to fall in early 2021, even as blue chips rose enough to carry the whole market higher—a feature unique to the late-stage major bubbles of 1929, 1972, 2000, and now 2021. Grantham writes:
But this historically familiar pattern was interrupted in December 2022 by the launch of ChatGPT and consequent public awareness of a new transformative technology—AI, which seems likely to be every bit as powerful and world-changing as the internet, and quite possibly much more so.
But every technological revolution like this—going back from the internet to telephones, railroads, or canals—has been accompanied by early massive hype and a stock market bubble as investors focus on the ultimate possibilities of the technology, pricing most of the very long-term potential immediately into current market prices. And many such revolutions are in the end often as transformative as those early investors could see and sometimes even more so—but only after a substantial period of disappointment during which the initial bubble bursts. Thus, as the most remarkable example of the tech bubble, Amazon led the speculative market, rising 21 times from the beginning of 1998 to its 1999 peak, only to decline by an almost inconceivable 92% from 2000 to 2002, before inheriting half the retail world!
So it is likely to be with the current AI bubble. But a new bubble within a bubble like this, even one limited to a handful of stocks, is totally unprecedented, so looking at history books may have its limits. But even though, I admit, there is no clear historical analogy to this strange new beast, the best guess is still that this second investment bubble—in AI—will at least temporarily deflate and probably facilitate a more normal ending to the original bubble, which we paused in December 2022 to admire the AI stocks. It also seems likely that the after-effects of interest rate rises and the ridiculous speculation of 2020-2021 and now (November 2023 through today) will eventually end in a recession.
Grantham says to beware of FOMO (fear of missing out), which comes along at the end of every great bubble. It’s incredibly seductive and hard to resist.
This bubble has crossed off all the boxes. It’s done all the things that a super bubble typically does.
We had a 11-year bull market (2009 to 2020), the longest in history.
It requires crazy behavior—we’ve had some of the great crazy behavior of all time.
It needs to accelerate at something like 3x the average rate of the bull market. It has done so.
At the end of every super bubble, the speculative stocks start to peel off and go down (even if the broad market goes up). This has happened. 40% of all NASDAQ stocks are down over 50%. This is the beginning of the end of the bubble: speculative stocks go down even as the market goes up. It’s a very rare condition that only previously happened in 1929, 1972, 2000.
Grantham concludes by asserting:
It is likely that we are at the beginning of a crash.
It would be unlikely that the market would not come down 50% from its peak.
And it would be unusual if the speculative stocks did not do worse than that.
CONCLUSION
Benjamin Graham and David Dodd, in Security Analysis (1934), wrote:
The ‘new era’ doctrine – that ‘good’ stocks were sound investments regardless of how high the price paid for them – was at bottom only a means of rationalizing under the title of ‘investment’ the well-nigh universal capitulation to the gambling fever. The notion that the desirability of a common stock was entirely independent of its price seems incredibly absurd. Yet the new-era theory led directly to this thesis… An alluring corollary of this principle was that making money in the stock market was now the easiest thing in the world. It was only necessary to buy ‘good’ stocks, regardless of price, and then to let nature take her upward course. The results of such a doctrine could not fail to be tragic.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
As a long-term value investor, how does one maximize long-term returns? Being hyper-selective – choosing the top 0.1% of ideas – is essential.
But something else that is essential is bet sizing. There’s actually a simple mathematical formula – the Kelly criterion – that tells you exactly how much to bet in order to maximize your long-term returns.
Both Warren Buffett and Charlie Munger are proponents of the essential logic of the Kelly criterion: bet big when you have the odds, otherwise don’t bet. Here’s Charlie Munger:
The wise ones bet heavily when the world offers them that opportunity. They bet big when they have the odds. And the rest of the time, they don’t. It’s just that simple.
As for Buffett, he famously invested 40% of his hedge fund into American Express in the late 1960s. Buffett realized a large profit. Later, Buffett invested 25% of Berkshire Hathaway’s portfolio in Coca-Cola. Buffett again enjoyed a large profit of more than 10x (and counting).
Some history of the Kelly criterion:
Claude Shannon was a fascinating character–he often rode a unicycle while juggling, and his house was filled with gadgets. Shannon’s master’s thesis was arguably the most important and famous master’s thesis of the twentieth century. In it, he proposed binary digit or bit, as the basic unit of information. A bit could have only two values–0 or 1, which could mean true or false, yes or no, or on or off. This allowed Boolean algebra to represent any logical relationship. This meant that the electrical switch could perform logic functions, which was the practical foundation for all digital circuits and computers.
The mathematician Ed Thorp, a colleague of Shannon’s at MIT, had discovered a way to beat the casinos at blackjack. But Thorp was trying to figure out how to size his blackjack bets as a function of how favorable the odds were. Someone suggested to Thorp that he talk to Shannon about it. Shannon recalled a paper written by a Bell Labs colleague of his, John Kelly, that dealt with this question.
The Kelly criterion can be written as follows:
F = p – [q/o]
where
F = Kelly criterion fraction of current capital to bet
o = Net odds, or dollars won per $1 bet if the bet wins (e.g., the bet may pay 5 to 1, meaning you win $5 per each $1 bet if the bet wins)
p = probability of winning
q = probability of losing = 1 – p
The Kelly criterion has a unique mathematical property: if you know the probability of winning and the net odds (payoff), then betting exactly the percentage determined by the Kelly criterion leads to the maximum long-term compounding of capital, assuming that you’re going to make a long series of bets. Betting any percentage that is not equal to that given by the Kelly criterion will inevitably lead to lower compound growth over a long period of time.
Thorp proceeded to use the Kelly criterion to win quite a bit of money at blackjack, at least until the casinos began taking countermeasures such as cheating dealers, frequent reshuffling, and outright banning. But Thorp realized that the stock market was also partly inefficient, and it was a far larger game.
Thorp launched a hedge fund that searched for little arbitrage situations (pricing discrepancies) involving warrants, options, and convertible bonds. In order to size his positions, Thorp used the Kelly criterion. Thorp evolved his approach over the years as previously profitable strategies were copied. His multi-decade track record was terrific.
Ed Thorp examined Buffett’s career and concluded that Buffett has used the essential logic of the Kelly criterion by concentrating his capital into his best ideas. Buffett’s concentrated value approach has produced an outstanding, unparalleled 66-year track record.
Thorp has made several important points about the Kelly criterion as it applies to long-term value investing. The Kelly criterion was invented to apply to a very long series of bets. Value investing differs because even a concentrated value investing approach will usually have at least 5-8 positions in the portfolio at the same time. Thorp argues that, in this situation, the investor must compare all the current and prospective investments simultaneously on the basis of the Kelly criterion.
In The Dhandho Investor, Mohnish Pabrai gives an example showing how you can use the Kelly criterion on your top 8 ideas, and then normalize the position sizes.
Say you look at your top 8 investment ideas. You use the Kelly criterion on each idea separately to figure out how large the position should be, and this is what you conclude about the ideal bet sizes:
Bet 1 – 80%
Bet 2 – 70%
Bet 3 – 60%
Bet 4 – 55%
Bet 5 – 45%
Bet 6 – 35%
Bet 7 – 30%
Bet 8 – 25%
Of course, that adds up to 400%. Yet for a value investor, especially running a concentrated portfolio of 5-8 positions, it virtually never makes sense to buy stocks on margin. Leverage cannot make a bad investment into a good investment, but it can turn a good investment into a bad investment. So you don’t need any leverage. It’s better to compound at a slightly lower rate than to risk turning a good investment into a bad investment because you lack staying power.
So the next step is simply to normalize the position sizes so that they add up to 100%. Since the original portfolio adds up to 400%, you just divide each position by 4:
Bet 1 – 20%
Bet 2 – 17%
Bet 3 – 15%
Bet 4 – 14%
Bet 5 – 11%
Bet 6 – 9%
Bet 7 – 8%
Bet 8 – 6%
(These percentages are rounded for simplicity.)
As mentioned earlier, if you truly know the odds of each bet in a long series of bets, the Kelly criterion tells you exactly how much to bet on each bet in order to maximize your long-term compounded rate of return. Betting any other amount will lead to lower compound returns. In particular, if you repeatedly bet more than what the Kelly criterion indicates, you eventually will destroy your capital.
It’s nearly always true when investing in a stock that you won’t know the true odds or the true future scenarios. You usually have to make an estimate. Because you never want to bet more than what the Kelly criterion says, it is wise to bet one half or one quarter of what the Kelly criterion says. This is called half-Kelly or quarter-Kelly betting. What is nice about half-Kelly betting is that you will earn three-quarters of the long-term returns of what full Kelly betting would deliver, but with only half the volatility.
So in practice, if there is any uncertainty in your estimates, you want to bet half-Kelly or quarter-Kelly. In the case of a concentrated portfolio of 5-8 stocks, you will frequently end up betting half-Kelly or quarter-Kelly because you are making 5-8 bets at the same time. In Mohnish’s example, you end up betting quarter-Kelly in each position once you’ve normalized the portfolio.
When running the Buffett Partnership, Warren Buffett invested 40% of the partnership in American Express after the stock had been cut in half following the salad oil scandal. American Express had to announce a $60 million loss, a huge hit given its total market capitalization of roughly $150 million at the time. But Buffett determined that the essential business of American Express–travelers’ checks and charge cards–had not been permanently damaged. American Express still had a very valuable moat.
Buffett explained his reasoning in several letters to limited partners:
We might invest up to 40% of our net worth in a single security under conditions coupling an extremely high probability that our facts and reasoning are correct with a very low probability that anything could change the underlying value of the investment.
We are obviously only going to go to 40% in very rare situations–this rarity, of course, is what makes it necessary that we concentrate so heavily, when we see such an opportunity. We probably have had only five or six situations in the nine-year history of the partnerships where we have exceeded 25%. Any such situations are going to have to promise very significant superior performance… They are also going to have to possess such superior qualitative and/or quantitative factors that the chance of serious permanent loss is minimal…
There’s virtually no such thing as a sure bet in the stock market. But there are situations where the odds of winning are very high or where the potential upside is substantial.
One final note: In constructing a concentrated portfolio of 5-8 stocks, if at least some of the positions are non-correlated or even negatively correlated, then the volatility of the overall portfolio can be reduced. Some top investors prefer to have about 15 positions with low correlations. Ray Dalio does this.
Once you get to at least 25 positions, specific correlations typically tend not to be an issue, although some investors may end up concentrating on specific industries. In fact, it often may make sense to concentrate on industries that are deeply out-of-favor.
Mohnish concludes:
…It’s all about the odds. Looking out for mispriced betting opportunities and betting heavily when the odds are overwhelmingly in your favor is the ticket to wealth. It’s all about letting the Kelly Formula dictate the upper bounds of these large bets. Further, because of multiple favorable betting opportunities available in equity markets, the volatility surrounding the Kelly Formula can be naturally tamed while still running a very concentrated portfolio.
In sum, top value investors like Warren Buffett, Charlie Munger, and Mohnish Pabrai–to name just a few out of many–naturally concentrate on their best 5-8 ideas, at least when they’re managing a small enough amount of money. (These days, Berkshire’s portfolio is massive, which makes it much more difficult to concentrate, let alone to find hidden gems among microcap stocks.)
You have to take a humble look at your strategy and your ability before deciding on your level of concentration. The Boole Microcap Fund that I manage is designed to focus on the top 5-8 ideas. This is concentrated enough so that the best performers–whichever stocks they turn out to be–can make a difference to the portfolio. But it is not so concentrated that it misses the best performers. In practice, the best performers very often turn out to be idea #5 or idea #8, rather than idea #1 or idea #2. Many top value investors–including Peter Cundill, Joel Greenblatt, and Mohnish Pabrai–have found this to be true.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
Perma-Pipe International Holdings (PPIH) makes specialty pipes which have coatings and linings for various harsh-condition transportation of oil, chemicals, and water. End markets are oil & gas, chemical, and infrastructure. PPIH also makes leak detection systems.
In the company’s most recent quarter, it reported EPS (earnings per share) of $0.40 versus $0.13 in the prior year. Furthermore, PPIH has a backlog of $75.5 million, which does not include $46 million in additional rewards secured subsequent to the end of the quarter.
The company is poised to continue increasing its EPS if they can continue increasing their revenues. This is a real possibility because PPIH provides products and services to Middle East regions that are investing in long-term infrastructure projects.
The market cap is $101.9 million, while enterprise value is $128.0 million.
Here are the metrics of cheapness:
EV/EBITDA = 5.42
P/E = 6.65
P/B = 1.49
P/CF = 6.78
P/S = 0.65
ROE is 28.3%, which is good.
The Piotroski F_Score is 7, which is quite good.
Insider ownership is 11.1%, which is decent. Cash is $9.5 million, while debt $35.5 million. Total liabilities to total assets is 51.9%, which is OK.
Intrinsic value scenarios:
Low case: If there’s a bear market and/or a recession, the stock could decline. That would be a buying opportunity.
Mid case: The company should have a P/E of at least 12. That would mean the stock is worth $23.06, which is about 80% higher than today’s $12.78.
High case: Arguably, the company should have a P/E of 15. That would mean the stock is worth $28.83, which is over 125% higher than today’s $12.78.
Very high case: If PPIH can continue to ramp its revenues, the P/E could reach 20. That would mean the stock is worth $38.44, which is 200% higher than today’s $12.78.
RISKS
If there’s a bear market or a recession, the stock would probably decline.
If the company does not continue to win new business, revenue and earnings would decline.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
PCS Edventures! (PCSV) offers a large catalog of STEAM curriculum (Science, Technology, Engineering, Art, and Math) and materials in the United States. Customers are schools and school districts from kindergarten through the collegiate level. Customers also include providers of after-school programs, home-school programs, summer programs, and corporate outreach programs.
PSCV differentiates itself in the very fragmented STEAM education market by being more professional and by providing excellent customer service. Furthermore, the company has demonstrated an ability to create engaging new courseware for kids. For instance, in 2016 PCSV quickly developed an education drone kit and curriculum when the company saw the drone market develeoping. And PCSV was one of the first to create a podcasting for kids curriculum and kit. This capability to speedily adjust and produce content valued by kids has been central to the company’s ability to win market share.
PSCV has many repeat customers. They’ve also been able to win larger orders from government programs such as the U.S. Air Force Junior ROTC.
Although PSCV’s quarter-to-quarter results can be lumpy, they continue to add more customers on a yearly basis.
The market cap is $31.55 million.
Metrics of cheapness:
EV/EBITDA = 6.16
P/E = 6.34
P/B = 3.58
P/CF = 9.75
P/S = 3.28
Normalized ROE is 38%, which is sustainable.
The Piotroski F_Score is 8, which is excellent.
Insider ownership is 61.99%, which is outstanding. Cash is $2.65 million, while debt is only $259k. Total liabilities to total assets is 7.65%, which is superb.
Intrinsic value scenarios:
Low case: If there’s a bear market and/or a recession, the stock could decline. That would be a buying opportunity.
Mid case: The company should have a P/E of at least 12. That would mean the stock is worth $0.47, which is about 90% higher than today’s $0.25.
High case: Arguably, the company should have a P/E of 15. That would mean the stock is worth $0.59, which is over 135% higher than today’s $0.25.
Very high case: The company could maintain its normalized ROE of 38%, in which case the stock could compound for many years.
RISKS
PSCV may not continue to win customers. This seems unlikely but it’s possible.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
Warren Buffett, the world’s greatest investor, earned the highest returns of his career from microcap cigar butts. Buffett wrote in the 2014 Berkshire Letter:
My cigar-butt strategy worked very well while I was managing small sums. Indeed, the many dozens of free puffs I obtained in the 1950’s made the decade by far the best of my life for both relative and absolute performance.
Even then, however, I made a few exceptions to cigar butts, the most important being GEICO. Thanks to a 1951 conversation I had with Lorimer Davidson, a wonderful man who later became CEO of the company, I learned that GEICO was a terrific business and promptly put 65% of my $9,800 net worth into its shares. Most of my gains in those early years, though, came from investments in mediocre companies that traded at bargain prices. Ben Graham had taught me that technique, and it worked.
But a major weakness in this approach gradually became apparent: Cigar-butt investing was scalable only to a point. With large sums, it would never work well…
Before Buffett led Berkshire Hathaway, he managed an investment partnership from 1957 to 1970 called Buffett Partnership Ltd. (BPL). While running BPL, Buffett wrote letters to limited partners filled with insights (and humor) about investing and business. Jeremy C. Miller has written a great book– Warren Buffett’s Ground Rules (Harper, 2016)–summarizing the lessons from Buffett’s partnership letters.
This blog post considers a few topics related to microcap cigar butts:
Net Nets
Dempster: The Asset Conversion Play
Liquidation Value or Earnings Power?
Mean Reversion for Cigar Butts
Focused vs. Statistical
The Rewards of Psychological Discomfort
Conclusion
NET NETS
Here Miller quotes the November 1966 letter, in which Buffett writes about valuing the partnership’s controlling ownership position in a cigar-butt stock:
…Wide changes in the market valuations accorded stocks at some point obviously find reflection in the valuation of businesses, although this factor is of much less importance when asset factors (particularly when current assets are significant) overshadow earnings power considerations in the valuation process…
Ben Graham’s primary cigar-butt method was net nets. Take net current asset value minus ALL liabilities, and then only buy the stock at 2/3 (or less) of that level. If you buy a basket (at least 20-30) of such stocks, then given enough time (at least a few years), you’re virtually certain to get good investment results, predominantly far in excess of the broad market.
A typical net-net stock might have $30 million in cash, with no debt, but have a market capitalization of $20 million. Assume there are 10 million shares outstanding. That means the company has $3/share in net cash, with no debt. But you can buy part ownership of this business by paying only $2/share. That’s ridiculously cheap. If the price remained near those levels, you could effectively buy $1 million in cash for $667,000–and repeat the exercise many times.
Of course, a company that cheap almost certainly has problems and may be losing money. But every business on the planet, at any given time, is in either one of two states: it is having problems, or it will be having problems. When problems come–whether company-specific, industry-driven, or macro-related–that often causes a stock to get very cheap.
The key question is whether the problems are temporary or permanent. Statistically speaking, many of the problems are temporary when viewed over the subsequent 3 to 5 years. The typical net-net stock is so extremely cheap relative to net tangible assets that usually something changes for the better–whether it’s a change by management, or a change from the outside (or both). Most net nets are not liquidated, and even those that are still bring a profit in many cases.
The net-net approach is one of the highest-returning investment strategies ever devised. That’s not a surprise because net nets, by definition, are absurdly cheap on the whole, often trading below net cash–cash in the bank minus ALL liabilities.
Buffett called Graham’s net-net method the cigar-butt approach:
…I call it the cigar-butt approach to investing. You walk down the street and you look around for a cigar butt someplace. Finally you see one and it is soggy and kind of repulsive, but there is one puff left in it. So you pick it up and the puff is free – it is a cigar butt stock. You get one free puff on it and then you throw it away and try another one. It is not elegant. But it works. Those are low return businesses.
When running BPL, Buffett would go through thousands of pages of Moody’s Manuals (and other such sources) to locate just one or a handful of microcap stocks trading at less than liquidation value. Other leading value investors have also used this technique. This includes Charlie Munger (early in his career), Walter Schloss, John Neff, Peter Cundill, and Marty Whitman, to name a few.
The cigar-butt approach is also called deep value investing. This normally means finding a stock that is available below liquidation value, or at least below net tangible book value.
When applying the cigar-butt method, you can either do it as a statistical group approach, or you can do it in a focused manner. Walter Schloss achieved one of the best long-term track records of all time–near 21% annually (gross) for 47 years–using a statistical group approach to cigar butts. Schloss typically had a hundred stocks in his portfolio, most of which were trading below tangible book value.
At the other extreme, Warren Buffett–when running BPL–used a focused approach to cigar butts. Dempster is a good example, which Miller explores in detail in his book.
DEMPSTER: THE ASSET CONVERSION PLAY
Dempster was a tiny micro cap, a family-owned company in Beatrice, Nebraska, that manufactured windmills and farm equipment. Buffett slowly bought shares in the company over the course of five years.
(Photo by Digikhmer)
Dempster had a market cap of $1.6 million, about $13.3 million in today’s dollars, says Miller.
Note: A market cap of $13.3 million is in the $10 to $25 million range–among the tiniest micro caps–which is avoided by nearly all investors, including professional microcap investors.
Buffett’s average price paid for Dempster was $28/share. Buffett’s estimate of liquidation value early on was near $35/share, which is intentionally conservative. Miller quotes one of Buffett’s letters:
The estimated value should not be what we hope it would be worth, or what it might be worth to an eager buyer, etc., but what I would estimate our interest would bring if sold under current conditions in a reasonably short period of time.
To estimate liquidation value, Buffett followed Graham’s method, as Miller explains:
cash, being liquid, doesn’t need a haircut
accounts receivable are valued at 85 cents on the dollar
inventory, carried on the books at cost, is marked down to 65 cents on the dollar
prepaid expenses and “other” are valued at 25 cents on the dollar
long-term assets, generally less liquid, are valued using estimated auction values
Buffett’s conservative estimate of liquidation value for Dempster was $35/share, or $2.2 million for the whole company. Recall that Buffett paid an average price of $28/share–quite a cheap price.
Even though the assets were clearly there, Dempster had problems. Stocks generally don’t get that cheap unless there are major problems. In Dempster’s case, inventories were far too high and rising fast. Buffett tried to get existing management to make needed improvements. But eventually Buffett had to throw them out. Then the company’s bank was threatening to seize the collateral on the loan. Fortunately, Charlie Munger–who later became Buffett’s business partner–recommended a turnaround specialist, Harry Bottle. Miller:
Harry did such an outstanding job whipping the company into shape that Buffett, in the next year’s letter, named him “man of the year.” Not only did he reduce inventories from $4 million to $1 million, alleviating the concerns of the bank (whose loan was quickly repaid), he also cut administrative and selling expenses in half and closed five unprofitable branches. With the help of Buffett and Munger, Dempster also raised prices on their used equipment up to 500% with little impact to sales volume or resistance from customers, all of which worked in combination to restore a healthy economic return in the business.
Miller explains that Buffett rationally focused on maximizing the return on capital:
Buffett was wired differently, and he achieves better results in part because he invests using an absolute scale. With Dempster he wasn’t at all bogged down with all the emotional baggage of being a veteran of the windmill business. He was in it to produce the highest rate of return on the capital he had tied up in the assets of the business. This absolute scale allowed him to see that the fix for Dempster would come by not reinvesting back into windmills. He immediately stopped the company from putting more capital in and started taking the capital out.
With profits and proceeds raised from converting inventory and other assets to cash, Buffett started buying stocks he liked. In essence, he was converting capital that was previously utilized in a bad (low-return) business, windmills, to capital that could be utilized in a good (high-return) business, securities.
Bottle, Buffett, and Munger maximized the value of Dempster’s assets. Buffett took the further step of not reinvesting cash in a low-return business, but instead investing in high-return stocks. In the end, on its investment of $28/share, BPL realized a net gain of $45 per share. This is a gain of a bit more than 160% on what was a very large position for BPL–one-fifth of the portfolio. Had the company been shut down by the bank, or simply burned through its assets, the return after paying $28/share could have been nothing or even negative.
Miller nicely summarizes the lessons of Buffett’s asset conversion play:
Buffett teaches investors to think of stocks as a conduit through which they can own their share of the assets that make up a business. The value of that business will be determined by one of two methods: (1) what the assets are worth if sold, or (2) the level of profits in relation to the value of assets required in producing them. This is true for each and every business and they are interrelated…
Operationally, a business can be improved in only three ways: (1) increase the level of sales; (2) reduce costs as a percent of sales; (3) reduce assets as a percentage of sales. The other factors, (4) increase leverage or (5) lower the tax rate, are the financial drivers of business value. These are the only ways a business can make itself more valuable.
Buffett “pulled all the levers” at Dempster…
LIQUIDATION VALUE OR EARNINGS POWER?
For most of the cigar butts that Buffett bought for BPL, he used Graham’s net-net method of buying at a discount to liquidation value, conservatively estimated. However, you can find deep value stocks–cigar butts–on the basis of other low “price-to-a-fundamental” ratio’s, such as low P/E or low EV/EBITDA. Even Buffett, when he was managing BPL, used a low P/E in some cases to identify cigar butts. (See an example below: Western Insurance Securities.)
Tobias Carlisle and Wes Gray tested various measures of cheapness from 1964 to 2011. Quantitative Value (Wiley, 2012)–an excellent book–summarizes their results. James P. O’Shaughnessy has conducted one of the broadest arrays of statistical backtests. See his results in What Works on Wall Street (McGraw-Hill, 4th edition, 2012), a terrific book.
(Illustration by Maxim Popov)
Carlisle and Gray found that low EV/EBIT was the best-performing measure of cheapness from 1964 to 2011. It even outperformed composite measures.
O’Shaughnessy learned that low EV/EBITDA was the best-performing individual measure of cheapness from 1964 to 2009.
But O’Shaughnessy also discovered that a composite measure–combining low P/B, P/E, P/S, P/CF, and EV/EBITDA–outperformed low EV/EBITDA.
Assuming relatively similar levels of performance, a composite measure is arguably better because it tends to be more consistent over time. There are periods when a given individual metric might not work well. The composite measure will tend to smooth over such periods. Besides, O’Shaughnessy found that a composite measure led to the best performance from 1964 to 2009.
Carlisle and Gray, as well as O’Shaughnessy, didn’t include Graham’s net-net method in their reported results. Carlisle wrote another book, Deep Value (Wiley, 2014)–which is fascinating–in which he summarizes several tests of net nets:
Henry Oppenheimer found that net nets returned 29.4% per year versus 11.5% per year for the market from 1970 to 1983.
Carlisle–with Jeffrey Oxman and Sunil Mohanty–tested net nets from 1983 to 2008. They discovered that the annual returns for net nets averaged 35.3% versus 12.9% for the market and 18.4% for a Small Firm Index.
A study of the Japanese market from 1975 to 1988 uncovered that net nets outperformed the market by about 13% per year.
An examination of the London Stock Exchange from 1981 to 2005 established that net nets outperformed the market by 19.7% per year.
Finally, James Montier analyzed all developed markets globally from 1985 to 2007. He learned that net nets averaged 35% per year versus 17% for the developed markets on the whole.
Given these outstanding returns, why didn’t Carlisle and Gray, as well as O’Shaughnessy, consider net nets? Primarily because many net nets are especially tiny microcap stocks. For example, in his study, Montier found that the median market capitalization for net nets was $21 million. Even the majority of professionally managed microcap funds do not consider stocks this tiny.
Recall that Dempster had a market cap of $1.6 million, or about $13.3 million in today’s dollars.
Unlike the majority of microcap funds, the Boole Microcap Fund does consider microcap stocks in the $10 to $25 million market cap range.
In 1999, Buffett commented that he could get 50% per year by investing in microcap cigar butts. He was later asked about this comment in 2005, and he replied:
Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I would do the same thing today with smaller amounts. It would perhaps even be easier to make that much money in today’s environment because information is easier to access. You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map–way off the map. You may find local companies that have nothing wrong with them at all. A company that I found, Western Insurance Securities, was trading for $3/share when it was earning $20/share!! I tried to buy up as much of it as possible. No one will tell you about these businesses. You have to find them.
Although the majority of microcap cigar butts Buffett invested in were cheap relative to liquidation value–cheap on the basis of net tangible assets–Buffett clearly found some cigar butts on the basis of a low P/E. Western Insurance Securities is a good example. It had a P/E of 0.15.
MEAN REVERSION FOR CIGAR BUTTS
Warren Buffett commented on high quality companies versus statistically cheap companies in his October 1967 letter to partners:
The evaluation of securities and businesses for investment purposes has always involved a mixture of qualitative and quantitative factors. At the one extreme, the analyst exclusively oriented to qualitative factors would say, “Buy the right company (with the right prospects, inherent industry conditions, management, etc.) and the price will take care of itself.” On the other hand, the quantitative spokesman would say, “Buy at the right price and the company (and stock) will take care of itself.” As is so often the pleasant result in the securities world, money can be made with either approach. And, of course, any analyst combines the two to some extent–his classification in either school would depend on the relative weight he assigns to the various factors and not to his consideration of one group of factors to the exclusion of the other group.
Interestingly enough, although I consider myself to be primarily in the quantitative school… the really sensational ideas I have had over the years have been heavily weighted toward the qualitative side where I have had a “high-probability insight”. This is what causes the cash register to really sing. However, it is an infrequent occurrence, as insights usually are, and, of course, no insight is required on the quantitative side–the figures should hit you over the head with a baseball bat. So the really big money tends to be made by investors who are right on qualitative decisions but, at least in my opinion, the more sure money tends to be made on the obvious quantitative decisions.
Buffett and Munger acquired See’s Candies for Berkshire Hathaway in 1972. See’s Candies is the quintessential high quality company because of its sustainably high ROIC (return on invested capital) of over 100%.
Truly high quality companies–like See’s–are very rare and difficult to find. Cigar butts are much easier to find by comparison.
Furthermore, it’s important to understand that Buffett got around 50% annual returns from cigar butts because he took a focused approach, like BPL’s 20% position in Dempster.
The vast majority of investors, if using a cigar-butt approach like net nets, should implement a group–or statistical–approach, and regularly buy and hold a basket of cigar butts (at least 20-30). This typically won’t produce 50% annual returns. But net nets, as a group, clearly have produced very high returns, often 30%+ annually. To do this today, you’d have to look globally.
As an alternative to net nets, you could implement a group approach using one of O’Shaughnessy’s composite measures–such as low P/B, P/E, P/S, P/CF, EV/EBITDA. Applying this to micro caps can produce 15-20% annual returns. Still excellent results. And much easier to apply consistently.
You may think that you can find some high quality companies. But that’s not enough. You have to find a high quality company that can maintain its competitive position and high ROIC. And it has to be available at a reasonable price.
Most high quality companies are trading at very high prices, to the extent that you can’t do better than the market by investing in them. In fact, often the prices are so high that you’ll probably do worse than the market.
Consider this observation by Charlie Munger:
The model I like to sort of simplify the notion of what goes on in a market for common stocks is the pari-mutuel system at the racetrack. If you stop to think about it, a pari-mutuel system is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.
Any damn fool can see that a horse carrying a light weight with a wonderful win rate and a good post position etc., etc. is way more likely to win than a horse with a terrible record and extra weight and so on and so on. But if you look at the odds, the bad horse pays 100 to 1, whereas the good horse pays 3 to 2. Then it’s not clear which is statistically the best bet using the mathematics of Fermat and Pascal. The prices have changed in such a way that it’s very hard to beat the system.
(Illustration by Nadoelopisat)
A horse with a great record (etc.) is much more likely to win than a horse with a terrible record. But–whether betting on horses or betting on stocks–you don’t get paid for identifying winners. You get paid for identifying mispricings.
The statistical evidence is overwhelming that if you systematically buy stocks at low multiples–P/B, P/E, P/S, P/CF, EV/EBITDA, etc.–you’ll almost certainly do better than the market over the long haul.
A deep value (cigar-butt) approach has always worked, given enough time. Betting on “the losers” has always worked eventually, whereas betting on “the winners” hardly ever works.
Classic academic studies showing “the losers” doing far better than “the winners” over subsequent 3- to 5-year periods:
That’s not to say deep value investing is easy. When you put together a basket of statistically cheap companies, you’re buying stocks that are widely hated or neglected. You have to endure loneliness and looking foolish. Some people can do it, but it’s important to know yourself before using a deep value strategy.
In general, we extrapolate the poor performance of cheap stocks and the good performance of expensive stocks too far into the future. This is the mistake of ignoring mean reversion.
When you find a group of companies that have been doing poorly for at least several years, those conditions typically do not persist. Instead, there tends to be mean reversion, or a return to “more normal” levels of revenues, earnings, or cash flows.
Similarly for a group of companies that have been doing exceedingly well. Those conditions also do not continue in general. There tends to be mean reversion, but in this case the mean–the average or “normal” conditions–is below recent activity levels.
Here’s Ben Graham explaining mean reversion:
It is natural to assume that industries which have fared worse than the average are “unfavorably situated” and therefore to be avoided. The converse would be assumed, of course, for those with superior records. But this conclusion may often prove quite erroneous. Abnormally good or abnormally bad conditions do not last forever. This is true of general business but of particular industries as well. Corrective forces are usually set in motion which tend to restore profits where they have disappeared or to reduce them where they are excessive in relation to capital.
With his taste for literature, Graham put the following quote from Horace’s Ars Poetica at the beginning of Security Analysis–the bible for value investors:
Many shall be restored that now are fallen and many shall fall than now are in honor.
Tobias Carlisle, while discussing mean reversion inDeep Value, smartly (and humorously) included this image of Albrecht Durer’s Wheel of Fortune:
(Albrecht Durer’s Wheel of Fortune from Sebastien Brant’s Ship of Fools (1494) via Wikimedia Commons)
FOCUSED vs. STATISTICAL
We’ve already seen that there are two basic ways to do cigar-butt investing: focused vs. statistical (group).
Ben Graham usually preferred the statistical (group) approach. Near the beginning of the Great Depression, Graham’s managed accounts lost more than 80 percent. Furthermore, the economy and the stock market took a long time to recover. As a result, Graham had a strong tendency towards conservatism in investing. This is likely part of why he preferred the statistical approach to net nets. By buying a basket of net nets (at least 20-30), the investor is virtually certain to get the statistical results of the group over time, which are broadly excellent.
Graham also was a polymath of sorts. He had wide-ranging intellectual interests. Because he knew net nets as a group would do quite well over the long term, he wasn’t inclined to spend much time analyzing individual net nets. Instead, he spent time on his other interests.
Warren Buffett was Graham’s best student. Buffett was the only student ever to be awarded an A+ in Graham’s class at Columbia University. Unlike Graham, Buffett has always had an extraordinary focus on business and investing. After spending many years learning everything about virtually every public company, Buffett took a focused approach to net nets. He found the ones that were the cheapest and that seemed the surest.
Buffett has asserted that returns can be improved–and risk lowered–if you focus your investments only on those companies that are within your circle of competence–those companies that you can truly understand. Buffett also maintains, however, that the vast majority of investors should simply invest in index funds:https://boolefund.com/warren-buffett-jack-bogle/
Regarding individual net nets, Graham admitted a danger:
Corporate gold dollars are now available in quantity at 50 cents and less–but they do have strings attached. Although they belong to the stockholder, he doesn’t control them. He may have to sit back and watch them dwindle and disappear as operating losses take their toll. For that reason the public refuses to accept even the cash holdings of corporations at their face value.
Graham explained that net nets are cheap because they “almost always have an unsatisfactory trend in earnings.” Graham:
If the profits had been increasing steadily it is obvious that the shares would not sell at so low a price. The objection to buying these issues lies in the probability, or at least the possibility, that earnings will decline or losses continue, and that the resources will be dissipated and the intrinsic value ultimately become less than the price paid.
(Image by Preecha Israphiwat)
Value investor Seth Klarman warns:
As long as working capital is not overstated and operations are not rapidly consuming cash, a company could liquidate its assets, extinguish all liabilities, and still distribute proceeds in excess of the market price to investors. Ongoing business losses can, however, quickly erode net-net working capital. Investors must therefore always consider the state of a company’s current operations before buying.
Even Buffett–nearly two decades after closing BPL–wrote the following in his 1989 letter to Berkshire shareholders:
If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the “cigar butt” approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the “bargain purchase” will make that puff all profit.
Unless you are a liquidator, that kind of approach to buying businesses is foolish. First, the original “bargain” price probably will not turn out to be such a steal after all. In a difficult business, no sooner is one problem solved than another surfaces–never is there just one cockroach in the kitchen. Second, any initial advantage you secure will be quickly eroded by the low return that the business earns. For example, if you buy a business for $8 million that can be sold or liquidated for $10 million and promptly take either course, you can realize a high return. But the investment will disappoint if the business is sold for $10 million in ten years and in the interim has annually earned and distributed only a few percent on cost…
Based on these objections, you might think that Buffett’s focused approach is better than the statistical (group) method. That way, the investor can figure out which net nets are more likely to recover instead of burn through their assets and leave the investor with a low or negative return.
However, Graham’s response was that the statistical or group approach to net nets is highly profitable over time. There is a wide range of potential outcomes for net nets, and many of those scenarios are good for the investor. Therefore, while there are always some individual net nets that don’t work out, a group or basket of net nets is nearly certain to work well eventually.
Indeed, Graham’s application of a statistical net-net approach produced 20% annual returns over many decades. Most backtests of net nets have tended to show annual returns of close to 30%. In practice, while around 5 percent of net nets may suffer a terminal decline in stock price, a statistical group of net nets has done far better than the market and has experienced fewer down years. Moreover, as Carlisle notes in Deep Value, very few net nets are actually liquidated or merged. In the vast majority of cases, there is a change by management, a change from the outside, or both, in order to restore earnings to a level more in line with net asset value. Mean reversion.
THE REWARDS OF PSYCHOLOGICAL DISCOMFORT
We noted earlier that it’s far more difficult to find a company like See’s Candies, at a reasonable price, than it is to find statistically cheap stocks. Moreover, if you buy a basket of statistically cheap stocks, you don’t have to possess an ability to analyze individual businesses in great depth.
That said, in order to use a deep value strategy, you do have to be able to handle the psychological discomfort of being lonely and looking foolish.
(Illustration by Sangoiri)
John Mihaljevic, author of The Manual of Ideas (Wiley, 2013), writes:
Comfort can be expensive in investing. Put differently, acceptance of discomfort can be rewarding, as equities that cause their owners discomfort frequently trade at exceptionally low valuations….
…Misery loves company, so it makes sense that rewards may await those willing to be miserable in solitude…
Mihaljevic explains:
If we owned nothing but a portfolio of Ben Graham-style bargain equities, we may become quite uncomfortable at times, especially if the market value of the portfolio declined precipitously. We might look at the portfolio and conclude that every investment could be worth zero. After all, we could have a mediocre business run by mediocre management, with assets that could be squandered. Investing in deep value equities therefore requires faith in the law of large numbers–that historical experience of market-beating returns in deep value stocks and the fact that we own a diversified portfolio will combine to yield a satisfactory result over time. This conceptually sound view becomes seriously challenged in times of distress…
Playing into the psychological discomfort of Graham-style equities is the tendency of such investments to exhibit strong asset value but inferior earnings or cash flows. In a stressed situation, investors may doubt their investment theses to such an extent that they disregard the objectively appraised asset values. After all–the reasoning of a scared investor might go–what is an asset really worth if it produces no cash flow?
Deep value investors often find some of the best investments in cyclical areas. A company at a cyclical low may have multi-bagger potential–the prospect of returning 300-500% (or more) to the investor.
Mihaljevic comments on a central challenge of deep value investing in cyclical companies:
The question of whether a company has entered permanent decline is anything but easy to answer, as virtually all companies appear to be in permanent decline when they hit a rock-bottom market quotation. Even if a business has been cyclical in the past, analysts generally adopt a “this time is different” attitude. As a pessimistic stock price inevitably influences the appraisal objectivity of most investors, it becomes exceedingly difficult to form a view strongly opposed to the prevailing consensus.
Consider the following industries that have been pronounced permanently impaired in the past, only to rebound strongly in subsequent years: Following the financial crisis of 2008-2009, many analysts argued that the banking industry would be permanently negatively affected, as higher capital requirements and regulatory oversight would compress returns on equity. The credit rating agencies were seen as impaired because the regulators would surely alter the business model of the industry for the worse following the failings of the rating agencies during the subprime mortgage bubble. The homebuilding industry would fail to rebound as strongly as in the past, as overcapacity became chronic and home prices remained tethered to building costs. The refining industry would suffer permanently lower margins, as those businesses were capital-intensive and driven by volatile commodity prices.
CONCLUSION
Buffett has made it clear, including in his 2014 letter to shareholders, that the best returns of his career came from investing in microcap cigar butts. Most of these were mediocre businesses (or worse). But they were ridiculously cheap. And, in some cases like Dempster, Buffett was able to bring about needed improvements when required.
When Buffett wrote about buying wonderful businesses in his 1989 letter, that’s chiefly because investable assets at Berkshire Hathaway had grown far too large for microcap cigar butts.
Even in recent years, Buffett invested part of his personal portfolio in a group of cigar butts he found in South Korea. So he’s never changed his view that an investor can get the highest returns from microcap cigar butts, either by using a statistical group approach or by using a more focused method.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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: jb@boolefund.com
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.
Zoomd Technologies (ZOMD.V in Canada and ZMDTF over-the-counter) is a marketing technology user-acquisition and engagement platform. “The company operates a mobile app user-acquisition platform that integrates with various digital media outlets. Its platform presents a unified view of various media sources to serve as a comprehensive user acquisition control center for advertisers and streamlines campaign management through a single point of contact. It also offers app marketing services. The company is based in Toronto, Canada.” Source of quote: https://seekingalpha.com/symbol/ZOMD:CA
Mobile media budgets are rapidly expanding, making mobile media devices the primary screen for advertisers’ media expenditures. Consumer spending in mobile apps is expected to continue its upward trend.
Zoomd helps companies navigate the complicated ‘outside the walled gardens’ space, where about half the marketing budget is spent.
Zoomd enables brands to expand globally with the least resources and the greatest impact, offering access to a substantial network of both global and local media channels through a single, unified service provider.
Zoomd is entrusted by global brands with customer acquisition. Zoomd’s top ten clients have been with Zoomd for an average of three years.
Since Q2-2023, under the direction of new CEO Ido Almany, Zoomd has engaged in strategic refocusing and the company’s performance has improved, including net income growth for 5 consecutive quarters and solidly positive net income of $2.27 million in Q2-2024. Also, revenue grew by 60% from Q1-2024 to Q2-2024.
Furthermore, from Q2-2023 to Q2-2024 under the direction of Almany, operating costs as a percentage of revenues have declined from 42% to 21%.
The market cap is $32.01 million, while enterprise value is $31.24 million.
Metrics of cheapness:
EV/EBITDA = 5.86
P/E = 11.09
P/B = 2.86
P/CF = 9.28
P/S = 0.94
ROE is 23.49%. This appears to be sustainable.
The Piotroski F_Score is 6, which is decent.
Insider ownership is 22.95%, which is excellent. Cash is $4.39 million, while debt is $3.63 million. Total liabilities to total assets is 47.6%, which is pretty good.
Intrinsic value scenarios:
Low case: If there’s a bear market or a recession and/or if demand for the company’s products decreases, the stock could decline.
Mid case: Annual EPS could reach at least $0.09 if the most recent quarter’s net income is matched or exceeded. With a P/E of 10, the stock would be worth $0.90 per share, which is 170% higher than today’s $0.3328 share price.
High case: The company’s performance could continue to improve. Annual EPS could reach $0.12. With a P/E of 12, the stock would be worth $1.44 per share, which is 330% higher than today’s $03328.
RISKS
Customer concentration: The company’s top 10 customers represent the vast majority of the revenues.
Increasing competition and emerging technological changes could challenge Zoomd’s ability to stay relevant and to capture new customers.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
Journey Energy is a Canadian oil and gas producer that is also becoming a significant producer of electric power. Journey’s stock is extremely cheap and the company is poised for significant growth in 2025.
The CEO Alex Verge has a long history of creating value in the oil and gas industry. And he has bought a great deal of Journey Energy stock on the open market.
The market cap is $109.7 million, while enterprise value is $143.4 million.
Metrics of cheapness:
EV/EBITDA = 3.04
P/E = 9.34
P/B = 0.46
P/CF = 1.86
P/S = 0.73
(The P/E is based on forward earnings.)
ROE is 3.85% but will increase in 2025.
The Piotroski F_Score is 5, which is OK. This also will likely improve in 2025.
Insider ownership is 7.6%, which is solid. Cash is $18.91 million, while debt is $64.29 million, almost all of which is due in 2029. Total liabilities to total assets is 46.4%, which is decent.
Intrinsic value scenarios:
Low case: If there’s a bear market or a recession and/or if oil prices decline, the stock could decline. This would be a buying opportunity.
Mid case: NAV based only on proved developed producing assets is $3.70 per share, which is 105% higher than the current stock price of $1.80 per share.
High case: EV/EBITDA today is 3.04 but should be approximately 8.00. That would mean an enterprise value of $377.37 million or a market cap of $343.67 million. This means an intrinsic value of $5.64 per share, which is over 210% higher than today’s $1.80.
RISKS
If there’s a bear market or a recession, the stock could decline temporarily.
Oil prices may even decline.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
Daktronics Inc. (DAKT) is the domestic industry standard in live events large screens—in which it has over 70% market share—and the market leader in scoreboards, digital billboards, and other programmable display solutions—in which it has 45% market share. The North American LED display market (90% of DAKT revenue) is expected to grow at a +20% CAGR and at a more rapid pace globally through 2028.
Moreover, the upgrade cycle from legacy LCD and older LED displays (SDR and 4-K) to next generation in HDR LED (higher resolution, more colors, better image clarity, content legibility, brightness, versatility, and durability) is still in its earlier stages with arena upgrades now much broader in size and scope.
Importantly, under the guidance of activists including Andrew Siegel, the board and, in turn, the company are very focused on margins, pricing discipline, and ROIC.
Also, keep in mind that roughly $100 million in orders per quarter never show up in the backlog due to short lead times.
The bottom line is that Daktronics has the best image quality and reliability in the industry. They are the go-to for pro sports and live entertainment venues.
The market cap is $564.45 million, while enterprise value is $543.61 million.
Metrics of cheapness:
EV/EBITDA = 6.10
P/E = 10.69
P/B = 2.37
P/CF = 5.31
P/S = 0.69
(The P/E is based on forward earnings.)
ROE is 25.8%, which is excellent.
The Piotroski F_Score is 6, which is decent.
Insider ownership is 13.3%, which is solid. Cash is $96.81 million, while debt is $75.97 million. TL/TA is 54.8%, which is reasonable.
Intrinsic value scenarios:
Low case: If there’s a bear market or a recession, the stock could decline. This would be a buying opportunity.
Mid case: EPS should be approximately $1.45 to $1.55. With a P/E of 15, the stock would be worth $21.75 to $23.25, which is about 80% to 90% higher than today’s $12.13.
High case: The company can probably sustain its ROE around 25.8%, which means that an investor who buys and holds the stock can likely enjoy close to 25% annual returns over time.
RISKS
If there’s a bear market or a recession, the stock could decline temporarily.
While Samsung’s performance in large event installations has been mixed, it could bid aggressively for future contracts in order to gain commercial placement of its brand name in arenas.
Commercial Construction Slowdown: C&I lending activity will likely be a headwind for office and other sub-segments. The company has very limited exposure to that area of commercial construction and overall new building.
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. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
ADF designs and engineers complex steel structures including airports, stadiums, office towers, manufacturing plants, warehouse facilities, and transportation infrastructure. Some of their sample projects include:
Miami International Airport
Lester B. Pearson International Airport (Toronto)
Logan Airport Pedestrian Bridges
One World Trade Center
Goldman Sachs HQ
M&T Bank Stadium (home of the Baltimore Ravens)
Ford Field (home of Detroit Lions)
Daimler-Chrysler Automotive Plant
Paccar (Kenworth Trucks) Assembly Plant Expansion
steel bridges and overpasses in Jamaica
Complex construction projects have higher pricing. And there’s less competition for building them because few fabricators are equipped to do this work for these reasons:
A more specialized labor force is needed.
Strange angles mean more complex welding.
Larger components require a larger fabrication base and more lifting capacity.
Other special equipment is often needed.
ADF has two facilities – a 635k sqft plant in Quebec, and a 100k sqft plant in Montana. Roughly 90-95% of revenues have come from the United States and only 5-10% from Canada.
Important Note: Although infrastructure spending can be cyclical, management believes that it has 3-5 years of revenue growth ahead of itself based on infrastructure spending needs across North America.
Here are the metrics of cheapness:
EV/EBITDA = 5.30
P/E = 8.6
P/B = 2.20
P/CF = 5.56
P/S = 1.10
The market cap is $288.83 million while enterprise value is $267.61. Cash is $56.3 million while debt is $34.9 million.
The Piostroski F_Score is 8, which is very good.
Insider ownership is 46%, which is outstanding. ROE is 30.67%, which is excellent.
Intrinsic value scenarios:
Low case: If there’s a bear market or a recession, the stock could decline 50%. This would be a buying opportunity.
Mid case: The current P/E is 8.6, but it should be at least 16. That means fair value for the stock is at least $16.43, which is over 85% higher than today’s $8.83.
High case: Assuming a 10x EV/EBITDA for fiscal year 2025, the stock would be worth $22.69, which is over 155% higher than today’s $8.83.
RISKS
A Republican victory in the U.S. presidential election would be a negative for infrastructure spending. However, ADF has not yet seen the benefit of the 2021 Infrastructure Bill, meaning that ADF’s revenue growth is not reliant on new government spending over the next few years.
A U.S. recession is quite possible, but ADF sees 3-5 years of revenue growth ahead.
An equal weighted group of micro caps generally far outperforms an equal weighted (or cap-weighted) group of larger stocks over time. See the historical chart here: https://boolefund.com/best-performers-microcap-stocks/
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 approachesintrinsic 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.
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
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 80% to 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 2020:
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 2020:
Microcap equal weighted returns = 15.8% per year
Large-cap equal weighted returns = ~10% 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 2020, versus 10% per year for an equal weighted large-cap approach.
Still, if you can do 4% 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 systematically implementing a value screen–e.g., low EV/EBITDA or low P/E–to a microcap strategy, you can add 2-3% per year.
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: https://boolefund.com/joseph-piotroski-value-investing/
BOTTOM LINE
If you invest in microcap stocks, you can get about 14% a year. If you also use a simple screen for value, that adds at least 2% a year. If, in addition, you screen for improving fundamentals, that adds at least another 2% a year. So that takes you to 18% a year, which compares quite well to the 10% a year you could get from an S&P 500 index fund.
What’s the difference between 18% a year and 10% a year? If you invest $50,000 at 10% a year for 30 years, you end up with $872,000, which is good. If you invest $50,000 at 18% a year for 30 years, you end up with $7.17 million, which is much better.
Please contact me if you would like to learn more.
My email: jb@boolefund.com.
My cell: 206.518.2519
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 approachesintrinsic 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: jb@boolefund.com
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.
