August 29, 2021
There are many ways to get rich. One of the best ways is through long-term investing.
A wise long-term investment for most investors is an S&P 500 index fund. It’s just simple arithmetic, as Warren Buffett and Jack Bogle frequently observe: http://boolefund.com/warren-buffett-jack-bogle/
But you can do significantly better—roughly 18% per year (instead of 10% per year)—by systematically investing in cheap, solid microcap stocks.
Most professional investors never consider microcaps because their assets under management are too large. Microcaps aren’t as profitable for them. That’s why there continues to be a compelling opportunity for savvy investors. Because microcaps are largely ignored, many get quite cheap on occasion.
Warren Buffett earned the highest returns of his career when he could invest in microcap stocks. Buffett says he’d do the same today if he were managing small sums: http://boolefund.com/buffetts-best-microcap-cigar-butts/
Look at 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)|
(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 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.
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: http://boolefund.com/joseph-piotroski-value-investing/
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.
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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: http://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.