This article was republished from a post on the Invest Before the Street blog
Looking for the next 100-bagger? You’d be surprised to find how many are the direct result of seemingly boring, ‘Outsider’ CEOs.
There is a lot of emphasis on finding the next Steve Jobs or the next Jeff Bezos in the microcap space. Can you blame them? A ‘visionary’ CEO behind a company looking to disrupt a dormant industry can certainly result in the next 10-bagger or 100-bagger.
Voss Value Is Betting On The American Consumer Recovery: Q4 Letter
In Q4 2020, the Voss Value Fund, LP and the Voss Value Offshore Fund, Ltd., returned 20.8% and 20.7% to investors net of fees and expenses, respectively, compared to a 31.4% total return for the Russell 2000, a 32.7% total return for the Russell 2000 Value, and a 12.2% total return for the S&P 500. Read More
But people like that are far and few between.
There’s much less emphasis on finding seemingly boring ‘Outsider’ CEOs. Yet history will show you that these ‘Outsider’ CEOs have created more 100-bagger investment opportunities than you can ever imagine.
So what does an ‘Outsider’ CEO look like?
The Outsiders is a book written by William Thorndike that profiles a few ‘Outsider’ CEOs and how they created immense value for shareholders over many years. Some of these CEOs include names like Warren Buffett, John Malone, and Henry Singleton.
If you haven’t read it yet, be sure to check it out by clicking here.
So how did they do it? Most weren’t visionaries like Steve Jobs or Jeff Bezos, the majority were actually pretty boring people from conventional backgrounds.
They dramatically grew shareholder value by being excellent leaders, and most importantly, by being very smart capital allocators.
I won’t discuss each one individually, so instead I’m going to focus on one: Henry Singleton.
Henry Singleton and Teledyne
“Henry Singleton of Teledyne has the best operating and capital deployment record in American business.” – Warren Buffett
Henry Singleton is known for being one of the greatest capital allocators ever at the helm of Teledyne. When Teledyne shares were sinking, Singleton was known for making extremely large repurchases of stock. Between 1972 and 1984, he bought back shares eight times, reducing the share count by approximately 90 percent. His track record? A 20% CAGR while at the helm.
Nowadays, people get excited about any sort of share buybacks. There’s a serious problem with that though:
Share buybacks are destructive if you’re repurchasing shares when the company is trading at a high valuation.
Companies seem throw money into buybacks whenever they have no other use for the capital, even if the share price is high. This completely goes against the idea of a share buybacks. Singleton used buybacks when he believed Teledyne’s shares were materially undervalued. That way, capital is getting used as efficiently as possible, and the return on capital is much higher.
People also seem to forget that Singleton did a lot more than timely buybacks. He also operated in reverse:
When Teledyne’s share price was materially overvalued, he used stock as currency and went on massive acquisition sprees.
In the 1960’s when conglomerates were the new hot thing, Teledyne traded at a massive premium. Singleton decided to use Teledyne stock as currency for acquisitions, making close to 130 during that period. If shareholders are willing to pay a premium to foot the bill, why bother taking on debt?
The Problem With Most Microcap CEOs
There is a major problem with most microcap companies:
They suck at telling their ‘story’, leaving most investors in the dark on what’s going on with their business, and deterring many who won’t bother taking a deeper look.
So you might be thinking: “Well, who cares! That leads to some of the best, undiscovered investment opportunities!”
I’d say your completely right. That’s usually where you’ll find some of the best opportunities.
But there’s still a problem. What’s the one common thing most microcap companies have to do in order to grow? Raise capital through equity raises.
Let’s go back to Henry Singleton and capital allocation 101: You buyback stock when it’s cheap and you issue stock when your equity is overvalued. So what usually happens with a microcap? Here’s the usual lifecycle I see:
Company A wants to focus on growth –>
Company A doesn’t put resources towards Investor Relations –>
Investors don’t understand the story, or never find Company A because of the lack of information –>
Company A’s stock trades at a substantial discount –>
Company A needs capital to grow –>
Company A tries to raise equity at the current, discounted share price –>
Dilution to shareholders is much more painful because equity was raised below fair value.
Am I saying CEOs should ‘pump’ their stock before an equity raise? Absolutely not. Their job is to run the business.
But one of the primary jobs of a CEO is to allocate capital. If a company won’t even put in a little effort to try and reach more investors (at a minimum build an investor presentation, come on hire an intern to do it), then they are damaging shareholder value every time they raise capital below the company’s current fair value.
Think about that for a second.
Just look at Elon Musk and Tesla. That company has barely made any money, yet Musk is constantly successful is raising boatloads of equity at extreme valuations by selling the ‘vision’ of Tesla. Why raise debt when you can have investors foot the bill through stock a high valuations?
Musk is a true visionary, but he is also one of the best salesman I’ve ever seen. Next time Tesla does an equity raise, notice how they unveil some sort of feature or new product recently before the raise is announced.
Think that’s a coincidence? Absolutely not.
One of the things Scott ad I are trying to do at WhyMicrocaps? is develop additional ways for companies to get their story out there, and help increase awareness of quality microcap companies.