Elizabeth Lilly’s notes from the 2018 Ivey Ben Graham Value Investing Conference in Canada from April 2018.
More coverage here.
Also check out our Sohn Conference notes right here. We will also be adding much more extensive coverage of the event in coming days for Premium readers in particular.
Also Baupost letter
Klarman On
the danger of Chinese leverage
Discipline while value investing in bubby times
Q1 hedge fund letters, conference, scoops etc
Elizabeth Lilly
- Small and micro cap
- Laying the groundwork and how to discover investment opportunities
- Rising interest rates environment
- There is a misnomer that small caps underperform in rising interest rates environment
- Because of higher costs
- The case for small and micro caps
- Value Investing – Graham and Greenwald
- Fundamental analysis is key: low P/E, low P/B
- Actively seeks undervalued stocks for less than their intrinsic value
- Malkiel & Fama
- Stock markets are efficient
- Market prices reflect the sum of all information
- Impossible to outperform market through stock selection and market timing
- Small caps outperform over full market cycle. Over a 15 year period, as illustrated above, a $10,000 investment in small cap company stocks would have grown to $124,669 compared to $90,064 for large company stocks
- Small caps during rising interest rates
- Average annual performance of small caps and large caps when treasury rates are rising and falling
- Since the inception of the Russell 2000 in 1979 through 2012
- Historically, small caps tend to perform better in rising rate environment than during a period of falling rates, perhaps attributable to improving economic activity, a harbinger of stronger earnings
- Long-term rates 10 year treasury rate
- Falling interest rates: small cap 10.2 vs large cap 12.4
- Rising interest rates: small cap 17.6 vs large cap 14.6
- Short term interest rates 3 month treasury rates
- Falling interest rates: small cap 9.4 vs large cap 13.0
- Rising interest rates: small cap 18.0 vs large cap 14.9
- Why small caps outperform in rising rates because they are more leverage
- Merger and Acquisition activity benefits small/micro caps
I. Activity: M&A transactions targeting small and micro cap companies continue at a robust pace, with US M&A volume reaching a record $2.3 trillion in 2016, up 35% from the prior year
II. Activists: Following a period of non-uniform equity performance, activists investors are prodding company managements to unlock value, often through a sale of the company
III. Attractive: in a lower than historical growth environment, large-cap companies seek inorganic growth through the acquisition of small companies
- We do not invest in companies that will be acquired
- They happen to be beneficiary of M&A environment
- Also, can be a beneficiary of activist
- Example: Supervalue – retail
- Have a lot of hidden real estate value (15 million square feet worth close to $30 a share)
- Do something about that, unlock the value
- Yesterday, they said they will unlock value by 5 million sqft, generating $400 million cash, an additional $11 per share of value that they will unlock
- The original intent was not because an activist would be involved but rather the analysis concluded it was mismanaged and that they needed management to understand where they can unlock the value
- Betted also that an activist would come along to unlock the value
- This is more and more of the case that small and micro caps
- Also a lot of smaller hedge funds who want to make a name for themselves by identifying these opportunities
- Also a lot of the small caps are bit size and easy for bigger companies to grow bigger and acquire them with cash
- Rise of hedge funds and high frequency trading, changes investment horizon
- Increased market volatility equals greater opportunity
- The ascendancy of hedge funds and high frequency trading firms have changed the investment environment, introducing volatility and shorter investment horizons
- Volatility -> greater inefficiencies -> better investment opportunities -> higher potential return
- Average turnover for funds
- 1986: 30%
- 2016: 44%
- Greater inefficiencies creates stocks on sale for no reason -> opportunity for bottom up fundamental research
- We do not rent stocks, we own businesses for a long time
- What is the most compelling piece of information as to why you should invest in small caps?
- Breakdown of analyst coverage by market cap
- Inefficiencies in under-researched companies
- Over 5 analysts: 21% - small cap vs 90% - midcap vs 99% - large cap
- 2, 3, 4 analysts: 8% small cap vs 1% for both midcap and large cap
- 1 analyst: 10% small cap vs 0 for mid cap and large cap
- No coverage: 45% of small caps have no coverage vs 1% no coverage for mid cap and large cap
- Opportunities in small caps: Growth in ETFs reduces institutional analyst coverage
- High research requirements and fewer providers
- Fundamental research uncovers undervalued/ mispriced stocks
- NOTE: they focus on 1 billion
***** 3 Billion and below are considered small cap and 45% have no coverage
- Note opportunity lies for those willing to do a lot of fundamental bottom up research, spend time rolling up your sleeves, talk with management (what is their vision for the business, what are their strategic plans)
- The small caps get no love from wall street and welcome those wanting to learn more, they are more willing to divulge where they expect and want the business to go (this is not inside information, they give you direction to follow and understand where the company will be)
- How do we come up with our ideas? What do we look for?
- Looking for good quality companies that get no respect, no body cares for them
- But they start to get respect, their stock goes up, market cap goes up, and then finally they get respect and 4-5 analysts cover them
- Need to have a general curiosity of the world
- So there is a company called Retail Now, an app on your phone that sends you coupons when you enter a store like Kohls
- I used it and asked myself, is this a public company? Sure it was
- Stock was around $7 with $4 cash in balance sheet
- It fell out of favor with wall street, there was like 1 analyst following
- I called management and said explain to me your vision, explain to me what you are going to do with the cash and they laid out their strategy for me, planning to buy back stock…
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