I keep rolling out as fast as I can find cash. Volatility has provided what I believe to be a really great opportunity. Last week I added a relatively new name. This is a micro cap that announced a 57% increase in revenue and a 226% increase in net income.
This was its third consecutive profitable quarter, and the company generated just over $2 million in free cash flow in the quarter. Not bad for a company with a market cap of about $32 million.
This is a security business that monitors over 80 fixed site locations for customers in various industries. They started this new business by servicing the oil and gas industry, but are beginning to serve other sectors as well.
What I need to understand is how much of their new business is from less cyclical industries away from energy. Energy service companies may have lower multiples than security business multiples, which tend to be significantly higher.
This may be one of those cases where the valuation multiple increases as the market appreciates the new business.
Speaking of multiplication… Multibagger stocks, or stocks whose price increases many times, usually need two things to happen for the price to increase dramatically. They need underlying fundamentals to keep improving their earnings, they need to grow their earnings rapidly, and they need to see their valuation multiples widen.
This is the true magic formula.
And it’s much easier to see this happen when a stock starts at a relatively low multiple. If the multiple is still 20, you have to do a lot of work to double or triple it.
But if your revenue starts at 5x and your PE grows to 20 thanks to market discovery and attention, you shouldn’t have to struggle too much. Almost all of them are in nanocap and microcap spaces.
I spoke with a colleague in New York about the market and what we’re seeing here in Canada. He was very surprised by some of the microcap valuations I mentioned.
His immediate response was, “Why doesn’t anyone buy these companies and take them private?” It was a difficult answer. I think there will be more private transactions.
The recent announcement that the Canadian government would start taxing corporate stock buybacks was perhaps another incentive to keep these small, profitable companies private.
If I am the owner and major shareholder of a small publicly traded company in Canada, I have to ask myself why should I remain listed if investors do not value my business fairly? With fewer tools at your disposal to correct market values, what benefits do you get from going public?
The whole idea of being a public company is based on the fact that public companies have traditionally been valued more highly than their private-market counterparts, which allows them to increase their equity capital when they need it. can lower the cost of
But what if the company doesn’t need capital, as many of these great little companies do? What’s the point of having a publicly traded currency if you value yourself less than a company sold on the private market?
The ongoing costs of being public, exchange filing fees, regulatory and financial filing fees, legal and consulting fees, investor relations fees, and annual audit costs increase dramatically. That is, if we can find an auditor to take on these “small” clients.
A small company I know has spent about $40,000 to over $120,000 in audit costs over the past year. Add the time and personnel needed to monitor and manage these items. For a decent little nanocap, the cost can easily reach +$500,000.
Canadian microcaps are currently very cheap and the fundamentals are good. No wonder so many CEOs we interviewed are unhappy with their company’s stock price. There has been increasing discussion about privatization and hostile takeover concerns.
In recent weeks, Thunderbird Entertainment has been targeted by dissident shareholders who have attempted to take over the company’s board of directors and consider selling the company to a larger organization.
Without the usual public market premiums, I think many companies would be swallowed by big companies or face hostile takeovers or management going private. This could improve valuations for these companies and revitalize investor interest in similar companies. The withdrawal of these cheap companies at healthy premiums is usually one of the triggers that start a new bull phase in a market or sector.
Many of the companies I own fit into this category. They are healthy growing companies that are starting to make sense as private companies. Adding $500,000 to your earnings can be a great incentive to take on the cost and effort of going private. Their value is far more significant without the cost of the open market.
As I said before, low cost remedies are… low prices.