December 10, 2023
The best way to build wealth is through long-term investing. The more wealth you have, the more freedom you have to achieve your goals in life.
A smart long-term investment for many investors is an S&P 500 index fund. It’s just basic arithmetic, as Jack Bogle and Warren Buffett frequently point out: https://boolefund.com/warren-buffett-jack-bogle/
But you can get much higher returns—at least 18% per year (instead of 10% per year)—by investing in cheap, solid microcap stocks.
Because most professional investors have large assets under management, they cannot even consider investing in microcap stocks. That’s why there continues to be a wonderful opportunity for enterprising investors. Microcaps are ignored, which causes most of them to become significantly undervalued from time to time.
Warren Buffett obtained the highest returns of his career when he invested primarily in microcap stocks. Buffett says that he could get 50 percent a year today if he were managing a small enough sum so that he could focus on microcap stocks: https://boolefund.com/buffetts-best-microcap-cigar-butts/
Check out this summary of the CRSP Decile-Based Size and Return Data from 1927 to 2020:
| Decile | Market Cap-Weighted Returns | Equal Weighted Returns | Number of Firms (year-end 2020) | Mean Firm Size (in millions) |
| 1 | 9.67% | 9.47% | 179 | 145,103 |
| 2 | 10.68% | 10.63% | 173 | 25,405 |
| 3 | 11.38% | 11.17% | 187 | 12,600 |
| 4 | 11.53% | 11.29% | 203 | 6,807 |
| 5 | 12.12% | 12.03% | 217 | 4,199 |
| 6 | 11.75% | 11.60% | 255 | 2,771 |
| 7 | 12.01% | 11.99% | 297 | 1,706 |
| 8 | 12.03% | 12.33% | 387 | 888 |
| 9 | 11.55% | 12.51% | 471 | 417 |
| 10 | 12.41% | 17.27% | 1,023 | 99 |
| 9+10 | 11.71% | 15.77% | 1,494 | 199 |
(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—are microcap stocks, which are stocks with market caps below $500 million. What jumps 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 actuality, the annual returns from microcap stocks will be 1-2% lower because of the cost of entering and exiting positions. So it’s better to 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.
VALUE SCREEN: +2-3%
By consistently applying a value screen—e.g., low EV/EBITDA, low P/E, low P/S, etc.—to a microcap strategy, you can add 2-3% per year.
IMPROVING FUNDAMENTALS: +2-3%
You can further increase performance by screening for improving fundamentals. One powerful 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 implement a simple screen for value, that adds at least 2% a year. If you then screen for improving fundamentals, that boosts performance by at least another 2% a year.
In brief, if you invest systematically in undervalued microcap stocks with improving fundamentals, you can get at least 18% a year. That compares quite well to the 10% a year you could get from an S&P 500 index fund.
What’s the difference between 10% a year and 18% a year? If you invest $100,000 at 10% a year for 30 years, you end up with $1.7 million, which is quite good. If you invest $100,000 at 18% a year for 30 years, you end up with $14.3 million, which is significantly better.
Please contact me with any questions or comments.
-
- 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. 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 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.
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.