Go Small Or Go Home

Cover Story, by Mark Robertson, Managing Partner


Posted on June 1st, 2016


One of our touchstones is that all-of-the-above investing makes it more likely that your long-term investing experience will be successful and rewarding.

Discovery Club. We like the idea of an effective blend. So yes, we’re interested in hunting down some actionable ideas among the most successful investors on our radar screen — seeking companies that aren’t on too many radar screens, yet. The discovery of smaller, promising and faster-growing companies has always been one of our favorite (and rewarding) activities. In that spirit, we’re expanding our efforts in this realm. They will come from a variety of sources and you’re invited to participate and contribute.

This is a reference to portfolio design and balance — specifically achieving a blend of blue chip stalwarts combined with a suitable mix of faster growing promising smaller companies. We generally aim for an overall sales growth forecast of 10-12% with suitable adjustments for time horizon and/or risk tolerance. Based on some recent soul searching, we’re now pondering how much “ relatively undiscovered company content” is enough. Or too much? In any event, we’ll be dedicating a larger slice of our weekly updates to DISCOVERY.

“I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.” — Warren Buffett, 1999 BusinessWeek Interview

Then he said in 2005: “Yes, I would still say the same thing today. In fact, we are still earning those types of returns on some of our smaller investments. The best decade was the 1950s; I was earning 50% plus returns with small amounts of capital. I could do the same thing today with smaller amounts.”

How did he do it? He said this: “You have to turn over a lot of rocks to find those little anomalies. You have to find the companies that are off the map – way off the map. When I got out of Columbia the first place I went to work was a five-person brokerage firm with operations in Omaha. It subscribed to Moody’s industrial manual, banks and finance manual and public utilities manual. I went through all those page by page.”

In order to help our subscribers find the companies that are “way off the map,” we’re expanding and digging into some areas that will provide a wider berth of study opportunities. As shown in the accompanying image, some of the higher return potential opporunities seem to be nested at the higher growth end of the sales growth forecast spectrum. The average growth forecast of the companies in that “fastest” quintile is 16.3% with the best return forecasts among all of the 20% slices of our coverage universe.

Return Forecasts as a Function of Company Growth. Some of our current motivation is on full display here. As we look at the spectrum of companies ranging from the fastest-growing to the slower growing stalwarts and display the average projected annual returns by quintile, it’s clear where some of the robust return potential is manifested. Manifest Investing (6/30/2016)

Achievable Excellence

Buffett’s words are somewhat haunting and provocative … and frankly they prompted some head scratching and soul-searching among many of us. Knowing that Peter Lynch has made very similar observations about the results achievable by individual investors (and we’d add, groups who meet and refer to themselves as a club) we decided to explore a little.

One example of exemplary performance that we found comes from the track record of Jim Simons and the Renaissance Technologies (RenTec) hedge fund. As the accompanying chart shows, the returns achieved by RenTec in the face of challenging periods has been exemplary and rarely equaled in the realm of investing.

As we shared in a recent weekly update, we believe that RenTec could be a source of compelling and yet undiscovered opportunities. Most of these will likely be smaller companies but a few larger enterprises will also come clear.

In the article, “How To Beat The Market By 20 Percentage Points”, Meena Krishnamsetty suggested: “Dump your hedge funds and imitate their small-cap stock picks.” We’d go a step further by rekindling our long-standing advice to monitor the portfolios of successful investors for idea generation, an approach echoed by Selena Maranjian via “What This Huge Hedge Fund Has Been Buying” (June 2015, Motley Fool).

Renaissance Technologies Hedge Fund: Track Record. Selena Maranjian shared that RenTec has delivered something on the order of 35% annual returns since 1982. The specific annual returns (via insidermonkey.com) are on display here for 1993-2004. It should be clear that these levels are exceptional and could be a source of ideas.

Recession, What Recession? This recession. Although it’s been subtle, we’ve labored under recessionary conditions when it comes to profitability over the last couple of years and the trend has been weak. Value Line has optimistic outlooks for 2017 and the 3-5 year time horizon. We hope they’re right. And if they’re right, it’s likely that many small companies may deliver superior performance.

Introducing Our Discovery Club

The motivation is clear. We want to discover companies that are still diamonds in the rough. Ken Kavula and I will be preparing the Best Small Companies list for this year during October and we want to pan for gold needles in the haystack.

The quest for excellent small companies never ends. Long time subscribers still smile over companies like Bio-Reference Labs, my personal favorite NavTeq, the early days of Buffalo Wild Wings … and yes, even the experience of people like Cy Lynch who first purchased (and still holds) shares of Home Depot back in the early 1980s. There are scores of examples like AFLAC purchased nearly 50 years ago. Our investment club had a cost basis of $0.19 for AFLAC a few years ago.

There are others but the idea is clear. We believe that we deliver maximum value when we expose actionable ideas for consideration and analysis.

To that end, the smaller companies have long been something of an afterthought during our weekly updates. Make no mistake, the traditional companies that form the core components of our all-of-the-above portfolios will receive no less diligence. We’re not suggesting for a heart beat that the emphasis and focus on quality companies at the core should change.

That said, it is possible that we should collectively consider discovering more companies like Chuck Allmon’s infatuation (and long term investment) in MOCON (MOCO). Companies like MOCO were the launching pad to exemplary performance for Allmon’s Growth Stock Outlook newsletter despite a perpetually bearish high level of cash equivalents. Check out our weekly updates on the Forum as we sift for suitable nuggets.

Mark

Mark Robertson

Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.

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