Podcast Summary
Underperformance of Small Cap Class: Small caps have underperformed larger indices but offer potential for high returns by discovering the next growth company
The small cap class has underperformed the larger S&P 500 and Nasdaq indices in recent years, with the Russell 2000 up only about 30% over the past 5 years compared to the S&P 500's and Nasdaq's significantly higher returns. This is largely due to the fact that most of the companies driving the gains in the larger indices are not present in the Russell 2000. However, Bill Mann, The Motley Fool's director of small cap research, emphasizes that investing in small caps is like "black diamond skiing" of stock investing, offering the potential to discover the next Home Depot or Chipotle before they become large corporations. Despite the challenges, identifying small companies with growth potential can lead to significant returns.
Factors contributing to underperformance of small caps: Institutional neglect and lack of premium make small caps potentially attractive undervalued investments, but their growth potential may be questioned.
The underperformance of small cap companies compared to large cap companies over the last 15 years can be attributed to several factors. Institutional investors and Wall Street analysts have largely abandoned small caps due to the lack of institutional trading and potential profits. Additionally, the abundance of data available on the internet has resulted in a lack of attention being paid to these companies. Oswald Demeter, an expert on valuation, has questioned the existence of the small cap premium, which was previously a reason for investors to pay a higher return for small companies due to their growth potential. This disappearance of the small cap premium could be seen as a positive or negative depending on one's perspective. On the one hand, it may make small caps more attractive as undervalued investments. On the other hand, it may indicate that small caps are no longer considered to have the growth potential they once did. Regardless, small caps remain an area where individual investors can potentially find opportunities that larger institutions may overlook.
Small caps: Challenges and opportunities: Small caps come with challenges like volatility, lack of info, and high costs, but they offer potential for long-term growth and an advantage in the crowded market.
Small cap companies, in aggregate, may not offer a premium due to the law of large numbers and the high costs they incur as public companies. However, there are extraordinary small cap companies with the potential for long-term growth. For investors interested in small caps, it's essential to have the right mindset, including accepting volatility, a lack of information, and feedback. Despite these challenges, small caps offer the opportunity to gain an advantage in a crowded market by looking where others aren't. Ultimately, whether to invest in small caps depends on an investor's risk tolerance, time commitment, and investment strategy.
Understanding small cap investing: Small cap investing involves high-risk, high-reward opportunities, requiring deep industry knowledge, market volatility handling, and long-term perspective. Focus on growth potential, not every news.
Small cap investing requires a deep understanding of the industry or sector, as well as the ability to handle market volatility and seemingly irrational price movements based on small pieces of news. Small cap companies can be high-risk, high-reward opportunities, and investors need to be prepared for the potential for significant swings in stock prices. It's important to focus on companies with the potential to grow large, rather than reacting to every small bit of news. Institutional investors may not always be helpful, and some small cap companies may benefit from limited attention. One example of a successful small cap investment is Winmark, a resale company that crossed the $1 billion mark and saw a surge in stock price. Overall, small cap investing requires patience, discipline, and a long-term perspective.
Institutional attention can impact a company's revaluation: Reaching a certain size can attract institutional attention and investment, potentially leading to higher valuations. Some companies deliberately avoid attention to focus on financials and business performance.
Institutional attention, whether it's good or bad, can serve as a catalyst for a company's revaluation. Institutional investors have mandates that limit their investment universe to larger companies, which can limit their ability to buy smaller companies, even if they were interested. However, once a company reaches a certain size, it can attract more institutional attention and investment, potentially leading to higher valuations. Brett Heffes, the CEO of Winmar, intentionally keeps his company off the radar by not engaging with analysts and not disclosing non-GAAP financial metrics. While some may view this as a deliberate avoidance of attention, Heffes believes that the business performance speaks for itself. Other smaller companies adopt similar strategies, and while communication style may not be a significant factor in evaluating a company, it's essential to consider the underlying financials and business performance.
Communicating Effectively as a Small Cap Company: Small cap companies like Boston Omaha need to clearly communicate their unique ventures and balance transparency with succinctness to avoid being overlooked or misunderstood in the investing world.
Effective communication is crucial for a company, especially when it comes to engaging with investors and analysts. However, there's a fine line between providing enough information and not overwhelming investors. Boston Omaha, a small cap company compared to Berkshire Hathaway, is an example of a company that could benefit from clearer communication. While welcoming comparisons to Berkshire Hathaway can be a communication strategy, it's not enough to give a full understanding of what the company is doing. Boston Omaha has various ventures, including billboards, broadband internet, and investments like Sky Harbor. The company's current low valuation, which is less than book value, raises questions about its true value. While some investors, like Warren Buffett, may place less importance on book value in today's information economy, others may still find it a valuable metric. Overall, companies like Boston Omaha need to strike a balance between being transparent and succinct to avoid being overlooked or misunderstood in the investing world.
The future of gig economy platforms is evolving with AI: While AI may displace some jobs on gig economy platforms, it also creates new opportunities for sophisticated tasks and enterprise customers. Platforms must adapt and address investor concerns to thrive.
While the rise of generative AI may lead to some dislocation in the gig economy platforms like Fiverr and Upwork, it also presents new opportunities. Some jobs may become obsolete, but others, particularly those involving sophisticated tasks, may become more prevalent. The platforms are adapting to this shift by attracting enterprise customers and offering more complex projects. However, they may need to address the narrative around AI's impact on their business and optimize their offerings to maintain investor confidence. Ultimately, the future of these platforms is not bleak, but rather, it's evolving. The key for investors is to stay informed about the latest trends and developments in the gig economy and the role of AI in shaping it.
ASR's ancillary services give it a competitive edge over utilities: Mexican airport concession holder ASR offers growth potential and ancillary services like cold storage, logistics, and parking, setting it apart from typical utility stocks with higher dividends and lower earnings multiples.
While Grupo Aeropuerto del Sureste (ASR) and utilities share similarities in terms of high fixed costs and guaranteed income, the growth potential and ancillary services offered by ASR make it more attractive than a typical utility stock. The Mexican airport concession holder, primarily focused on traffic in Cancun, is poised for sharper growth due to the addition of ancillary services such as cold storage, logistics, and parking, which utilities cannot offer. These options provide ASR with a competitive edge and greater revenue opportunities. Despite paying a high dividend and having a fairly low earnings multiple, ASR's potential for growth and additional revenue streams set it apart from traditional utility stocks.
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