How I Get Over 21% Average Annual Returns By Investing in Small Cap Stocks

Jason Rivera

United States
Stocks
Long-Term Investor

Who are you and what’s your story?

I’m a self-taught value investor who focuses on small and obscure public companies to buy for my investors and subscribers.

I’m the author of the acclaimed value investing education book How To Value Invest, On Float, and as of this writing am finalizing the Second Edition of How To Value Invest.

I’ve run this blog Value Investing Journey for more than eight years and the sites have been named a top 50 value investing blog in the world four times now.

And our two value investing and education sites have been Named Top 15 Value Investing Podcasts In The World.

I also manage investment portfolios for clients.

In the first 8 years of my investment career, I’ve produced investment returns for the portfolios I manage of 21.7% per year on average. This is compared to about 9.9% for the market on average every year during this same period.

You can read a more detailed performance review for 2019 here.

I’ve written for several publications and investment newsletters including Seeking Alpha, The Palm Beach Letter, Wyatt Research, Insider Monkey, Guru Focus, and others.

I got started in investing by necessity.

I couldn’t work or go to college after high school due to long term severe dizziness issues – that I still deal with to this day as I’m about to turn 34.

But I also had a wife who was pregnant with our first child that I needed to be able to provide for at some point.

In high school, we had this class called consumerism and one of the things learned in that class was about stocks.

Because of my physical limitations by default I chose to learn about stocks and investing because it was the only thing I was remotely interested in that I could also do from home.

What do you invest in and why did you start investing?

I invest in mostly small – small, micro, and nano-cap – stocks in the portfolios I manage.

I do this so I can get a legal informational advantage over other investors who either can’t or won’t invest in these small stocks.

What does this mean?

Larger institutional investors sometimes either legally can’t invest in small stocks below a certain size.

Or they won’t because it won’t make a huge difference in their results.

For example, Apple at a $2 trillion market cap investing in a stock worth $50 million will do almost nothing for them in the short or long term unless it’s in some kind of massive new trend. So most of the time they won’t invest in these kinds of smaller opportunities.

And because many can’t or won’t invest in these kinds of smaller stocks I can get a legal informational advantage by researching them because fewer people are doing so.

And when I say small… The smallest public stock I’ve invested in had a $12 million market cap when I invested in it. And the smallest stock on my watchlist has a $4 million market cap.

For example, many large companies and institutional investors won’t invest in stocks that have a market cap below $10 billion… This is where so-called Large Cap stocks begin.

Note here though – I tell this to everyone I talk to about investing in these tiny companies… Unless you know what you’re doing you shouldn’t invest in these kinds of stocks.

Even though they are my favorites to invest in – 99% of them are still terrible and can blow up your portfolio real quick if you don’t know how to evaluate stocks and their financials on a deep level.

I’m also transferring my knowledge of value investing and evaluation and valuation to looking at investing in private businesses and commercial real estate as well.

The portfolios I manage are in the six figures range. But I’ve turned down almost $2.5 million in funds that people wanted to invest with me.

Why?

Because they only wanted to invest in stocks a couple of years ago and I haven’t bought a new stock in almost 6 years now due to the sky-high – and still rising – valuations on stocks worldwide.

I won’t bend my strict criteria just to buy something… And I would have felt bad taking those investors capital and just having it sit there and earning fees off them.

I started investing real money almost 11 years ago now and got my ass kicked by Mr. Market.

Within 6 months of investing real money, my portfolio was down 50% because I was only investing based on financial ratios I learned from books and via my online research. And in most cases, I didn’t even know what business the stock was in.

Luckily I’d only started investing with $500. But the 50% loss in 6 months shocked me into learning the craft of investing. It forced me to learn the real ins and outs of investing like reading financial statements thoroughly, learning business models and competitive advantages, valuations, etc.

Without this, I wouldn’t be where I am today.

The biggest lesson from this that I teach all my students… Never rely only on the numbers. This is just a starting point if good. And a disqualifier if bad.

Walk us through your process of identifying and executing on investment opportunities?

I’m a deep and contrarian value investor.

Most of the time I invest in Warren Buffett type compounders that are small, but that produce a lot of free cash flow compared to their size… And also have strong balance sheet strength with little debt and high cash levels.

It also must be undervalued for me to buy it. And better yet if it has some competitive advantages.

I’ll look at and invest in almost any country on Earth. And as of right now my watchlist has more than 23 countries represented on it in terms of where the companies headquarters and main operations are located

In terms of specific metrics I love and use them all the time… I look for the stock to have an EV/EBIT – enterprise value to operating income – below 8. This helps ensure it’s undervalued and gives me a margin of safety.

I also look for my investments to have the free cash flow to sales – FCF/Sales – ratios above 5% consistently.

Operating profit margins above 10% consistently.

And also return on invested capital (ROIC) ratios above 10% consistently.

Why?

Because if a company has all these things there’s a good chance that not only is it undervalued when I do my full intrinsic valuations.

But also that it likely has a strong balance sheet due to its stellar business operations.

And it also may have some competitive advantages as well.

On occasion I also invest in Ben Graham NCAV – net current asset value – stock that’s deeply undervalued or some kind of special situation like a spin-off or going private transaction as well.

Most of the time I plan to buy and hold for years… For reference to this, the longest stock I’ve owned I’ve now done so for 8 years.

In terms of when I sell a stock, I have 3 main rules…

If management at a stock I own starts doing stupid stuff after I buy.

If the underlying investment thesis either deteriorates overtime – or I figured out afterward my thesis was wrong.

If I find something better to buy.

That’s it.

Unless any of those three things are met I hold the stock barring an NCAV or special situation type of investment.

I also have one major rule before buying as well.

If after reading hundreds of pages of historical financial docs and news on a company… If I don’t 100% trust that management is doing what’s in the best interests of all shareholders I don’t buy the stock.

Ever.

It doesn’t matter how great the opportunity is or how undervalued the stock is.

Because I’m a long-term buy and hold investor if I can’t trust management I don’t buy. No matter what.

These 4 rules combined have saved me more money, time, and frustration than anything else I do in investing.

What books, platforms or resources have you found useful?

I use Morningstar.com to do my initial evaluation of a stock.
And then from there, I read a ton of annual reports, proxies, quarterly reports, and anything else I can find online about the company.

No resource I use is paid for. All done free online via either Morningstar, the company’s site, or Google search.

My favorite investing/business books are in no particular order.

The Intelligent Investor

 

Value Investing From Graham To Buffett And Beyond

Titan – biography of John D. Rockefeller

 

Biography of Andrew Carnegie by David Nasaw

 

The First Tycoon – Biography of Cornelius Vanderbilt

 


The Billionaire Who Wasn’t – Biography of Chuck Feeney

In terms of general books to get you in the right mindset to become a great investor I recommend… Again in no particular order.

I read fairly widely, but am a huge believer in having the proper mindset as an absolute must for becoming a great investor which is why I read and recommend so many books from this arena.

What advice would you give to someone who’s just starting out in investing?

I write about this in a blog post I did a while back, the main thesis is to look at becoming an investor as a craft.

You want to become great at it. So you must dedicate yourself to learning and practicing to become the best.

To do this, you need to:

  1. Be patient
  2. Be an autodidact
  3. Have strict and disciplined processes
  4. Practice everything you learn as you learn it
  5. Get the fundamentals down pat
  6. Be selfish with your time
  7. Never get complacent
  8. Get confidence in your abilities
  9. Never be afraid of mistakes.
  10. Be obsessive.
  11. Write your analysis down and let others critique your work.

You can learn more about what each of these means in the original post here.

What investment opportunities are you excited about at the moment?

Frankly, none other than reinvesting and growing my own businesses.

Stock valuations are at or near all-time highs… The only time market valuations were higher was during the Tech Boom and Bust in the early 2000s. Yes, valuations right now are far higher than even right before the Great Depression.

Valuations for private businesses are also high. And so are valuations on commercial real estate.

This has been the case for the better part of the last 6 years which is why I haven’t invested in much other than in myself and my businesses.

Can you share a story about an investment opportunity that you passed on and went on to grow beyond your expectations?

Way too many…

One example is a recent one though that I’d like to share.

I’d owned this stock for years but it had problems not only in a cyclical industry-wide recession… But this caused issues for the individual businesses as well. As in potentially going out of business type of problems.

The stock dropped from around $13 per share to $1 per share due to the massive issues but I held.

I do 100’s of hours of research into any stock I own so I know them and their industries and competitors intimately.

This gives me the confidence to not only buy but hold – and potentially buy more – if the stock drops. Because unless one of the 3 criteria I mentioned above happens I keep holding.

As the stock dropped I evaluated the company again and decided nothing had changed economically for the company so I held.

I debated buying more for a couple of days but succumbed to what Warren Buffett calls thumbsucking syndrome and hadn’t made a final decision yet to buy more when some great news about the company’s turnaround sent shares skyrocketing.

It’s now up from around $1 per share to $14 per share as of this writing in a matter of months.

I knew I should have bought more… But hesitated and paid for it.

This entire process shows that you need to have the conviction to buy and hold – even when your stock drops 80%+ in a short time…

But also that you need to be more decisive when considering to buy more because I could have seen a 14X increase in a matter of weeks if I would have been more decisive.

Where can readers go to learn more about you?

You can find me on my main site Value Investing Journey, where we release a ton of free content to help you learn how to become a world-class value investor.

I also teach others how to become great value investors via two of our services: The Value Investing Masterclass, Our Value Investing Coaching Program

I also have various other mini-courses, masterminds, and other online and live events related to value investing and capital allocation as well.

You’ll also find content on my YouTube channel.

Or on my two podcasts.

Thanks to
Jason Rivera

 for doing this interview.

If you have any questions or comments, leave a reply below.

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