What they don't tell you about microcap/smallcap investing.

(a thread) 👇
1/ It is extremely lonely.

For a large part of your investing cycle, you will be holding some tiny companies and you know that even if you talk about it, you will either be wrong 80% of the time, or people will just trash it.
2/ You're wrong more often than you're right.

People who seem to be picking amazing smallcaps/microcaps all the time aren't telling you about their failures. Or they haven't even invested and just trying to give you FOMO for personal gain (attention, followers, services).
3/ Accept uncertainty and build a process around it

In smallcaps/microcaps, certainty is an illusion. Anyone claiming otherwise is fooling you or themselves or both. No matter how certain a bet seems, listen to that voice over your shoulder.
4/ Margin of safety lies in valuation, and nothing else.

Always value the business for the worst case - no growth happens, all assumptions go wrong, business earns only enough to survive. Check historical data - past period of outperformance (if any), reasons, etc.
5/ Learn the basics of supply and demand in illiquid companies

In this space, a hundred buyers and an influencer can put a stock on upper or lower circuits for days. People constantly judge small companies based on how many circuits they've had. It means nothing.
6/ If they're discussing on social media, the margin of safety is likely gone

Self explanatory - either you were holding before everyone got excited, or you should be wait for the inevitable reversion to mean when expectations are missed.
7/ You will encounter many false starts

A false start is when there is a temporary rise in earnings, which you pick up as a positive sign. Experience is knowing probable causes for temporary outperformance. Many companies had several false starts before they really took off.
8/ Low PE is not a bargain- it is a default

Smallcaps and microcaps deserve to trade at low PEs. Don't compare these companies with the index and fancied stocks of the day.
9/ Bet on honest, experienced management and favourable macro conditions for the industry

You are not looking for visionary management, you're just looking for people and companies well placed grab an opportunity and come out stronger once it plays out.
10/ Tiny companies usually don't have strong balance sheets

At small scale of operations, there is a lot of inefficiency. Eg. working capital is usually a big cost, and plant & machinery generally tend to be old and obsolete.

It isn't about how it IS, but how it COULD BE.
11/ Governance analysis is very nuanced

Small cos need promoter support, hence share warrants, unsecured loans and related party transactions are common. Often, these improve as the company grows. Conflict of interest and compliance lapses are the main red flag I look for.
12/ Scaling operations is not a linear exercise, it's more start and stop

In tiny companies, growth consumes precious cash not just for capex but also manpower and increased working capital. As an organization, it has to be adjust to being larger. This doesn't happen overnight.
13/ How well do you sleep at night?

Separates the wheat from the chaff. If price movements keep you up at night, you don't have the temperament or your gut knows you effed up. Strong emotions on change in price are a good indicator of the underlying basis for the decision.
14/ Watch only business performance and have a stomach for volatility

30-40% drops can be stomach churning, it will either force you out of the space, or you will adapt and learn. Even then, broader market trends result in significant price erosion for no discernible reason.
15/ Volatility is actually your friend

Volatility means companies experience sharp movements in prices due to broader trends or non-specific reasons. Smallcaps/microcaps rise and also fall the fastest. Other people's fear and euphoria is your opportunity (selectively).
16/ Watching and understanding is more useful than jumping in and out

Microcap stories play out over elongated time frames, with stops and starts. Watch for long periods and understand the industries. The more you track, the more you learn about the space.
17/ Use primary sources to generate ideas

Read exchange announcements and annual reports, and to a lesser extent investor presentations, to get the information you need. Screeners are fine but account for cyclicality. Avoid ideas on SM unless from trusted sources.
18/ Understand business and industry cycles.

In the long run, your objective is to understand structures and economics for various industries and sectors so you can better understand events of change taking place in small and tiny companies. This is compounded knowledge.
19/ Use credit rating reports

Lot of tiny companies have credit ratings for loans oustanding or in the past. These can have information you won't find in the absence of any presentations or concalls. Credit reports will often be the only third party info source available to you.

Note: there is no specific order to the Tweets, just kept typing as they popped up in my head. There will always be exceptions to the general concepts discussed above, nothing is ever absolute.

RT the first Tweet if you like the thread.

Practice safe allocation, spread your bets and try not to exit while business is till performing and has a runway. Also, don't be in a hurry to exit something you know well - you can afford to wait if cost of acquisition is low.

Perhaps the most important - don't be afraid to average up if the business performs as expected. As business grows larger, the prospects could be better and bigger than you thought in the first place. Don't get anchored but still practice risk management.

Avoid trimming positions solely because they've grown too large through appreciation. Have strong reasons or a definite strategy. Don't break compounding unless you absolutely have to. Speaking from experience.

Don't be afraid to email or call companies. For most promoters, company is like their child. They may not be very good at what they do, but they still like to talk about themselves, as all humans do.

Success rate will be low but you might just get information.

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More from @leading_nowhere

28 Sep
Every annual report tells a story.

In small companies, you can read between the lines to get a feel of the management style and business economics.

I take Fredun Pharmaceuticals Ltd (FPL) to illustrate how to go about this (it's not pretty).

Let's go 👇 (1/n)
Please note that the main objective of this review is to get a preliminary understanding without doing a thesis.

It is oriented towards a "quick and dirty" review to decide if you want to dig deeper.

Review financials on a screener website before reading further. (2/n)
Now, you can already guess Fredun Pharmaceuticals is named after Fredun Medhora. His mother, Dr Daulat Medhora and his father, Nariman Medhora, are the original promoters of the company. Interestingly, Nariman Medhora has stepped down from active involvement in June 2021. (3/n)
Read 25 tweets
26 Aug
Noticed Shri Jagdamba Polymer Limited (SJPL) featuring recently, as a long term pick.

It's difficult to find a bigger potential conflict of interest from a minority investor's perspective.

Let's see👇 (1/11)
Fact: SJPL promoters have another unlisted entity Shakti Polyweave Pvt Ltd (SPPL) with exact same business. ALways a red flag, but lots of promoters have small side-busineses. Fortunately, public credit reports of SPPL have tons of useful information to understand further. (2/11)
SJPL was founded by RB in 1985, whereas Shakti Polyweave Private Limited (SPPL) founded in 1997 and identifies HA as the main promoter. While RB serves as director on both SJPL and SPPL, HA seems full-time in SPPL but does not seem to have any fixed role in SJPL. (3/11)
Read 12 tweets
25 Aug
Asian Granito (AGL) scrambling to ensure the upcoming Rs 225 Cr rights issue doesn't run into headwinds. Promoters recently sold 12% of AGL to invest into a related party, and promoters will now invest back into AGL via rights issue! What's up 👇 (1/7)
Promoters justify 12% stake sale in AGL for investment into a related entity Adicon Ceramica LLP, where they state they have no holding. Weak argument, because business is intertwined and a designated partner of the LLP is a director in all material subsidiaries of AGL. (2/7)
AGL recently sold 18% holding in an associated listed company Astron Paper & Board, for 47 Cr. Now, promoters in this clarification state the rights funds will be used to primarily clear debt of Crystal Ceramics (CCL). But CCL isn't heavily indebted, debt is only Rs 140 Cr. (3/7)
Read 7 tweets
22 Aug
This thread below was an example of allocation policies you don't want to find when analysing a rights issue. Let's see the other end of the spectrum. Natural Capsules Limited (NCL) announced a rights issue on 05 Aug 21 to raise growth capital. (1/26)
Why NCL with 100 Cr market cap? There are many small manufacturers like NCL. Without economies of scale, smaller players suffer from high fixed costs, obsolete machinery and lower operating efficiencies, which generally depresses margins and constrains future growth.(2/26)
Small companies can take decades to grow to a size where economies of scale kick in, or where they are able to benefit from favourable supply-demand situations. The objective, thus, is finding companies at cusp of higher return on invested capital and economies of scale. (3/26)
Read 28 tweets
20 Aug
There are a few things to look at when analyzing a rights issue as a special situations play. Capital allocation skills of the management rank right at the top. Fundamental question - is it growth capital or a cover-up for fiscal misprudence in the past? (1/13)
Let's see how to spot the ones that may be covering up past fiscal misprudence. In this example, I take NxtDigital Limited, with 1100 crore market cap. Previously called Hinduja Ventures, it provides TV broadcast and broadband services. (2/13)
NxtDigital announced a rights issue of Rs 300 crore in May 2021, in 2:5 ratio at a price of Rs 300/share. Further, it also paid Rs 5.50 annual dividend for FY21. At the same time, company has incurred negative PAT at consolidated level for 7 consecutive years. (3/13)
Read 14 tweets
10 Aug
What we're seeing in small caps and mid caps - broad decline and lack of momentum - is natural in the rotation cycle. If your companies continue to grow earnings, they'll be back and beyond in a few quarters. If not, you picked lemons. No amount of narrative can change this.
This is usually the time when investors start to doubt the narrative they believed so far. Pain of loss hurts a lot more than pleasure of profit. It's scientifically proven. It's difficult to believe "sector has tailwinds" when your own money is disappearing before your eyes.
It's easy to imagine a future where you're just minting money punting on stocks (I did too). Many would contemplate leaving their jobs. And now there's that knot in the pit of your stomach. Or maybe I'm too early? Another 20% down should definitely trigger it.
Read 11 tweets

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