8 Lessons

Good morning investors,

Hope everyone is having a great start to their Friday despite the volatility in small-cap stocks. A lot happened this week. Two companies that I am invested in reported their third quarter earnings. I will put out full updates on these stocks over the next couple days so keep an eye out on them. If you are a Alpha Letter Pro subscriber you can see the original research reports on these companies below.

The first company reported worse than expected earnings and fell over 20%. Management also reported that fourth quarter earnings will be challenging. I think Wall Street is short-sighted in this reaction as I used the sell-off to add to my position. One of their competitors (who I hold a major position in) is reporting on the 30th. I am expecting strong results.

The second company reported earnings in-line with my estimates. After their earnings call today the stock went up almost 20%, to fall back down to where it has been trading the past few days. I think when Wall Street begins to understand the full story for 2022 the stock can re-rate pretty quickly to the $6-7 per share range. My long-term price target is north of $10 which is a clean double at the current valuation.

It should be noted that this company is beating all of their competitors by a wide margins in terms of growth and margin expansion. Despite the outperformance, this company trades at a wide discount to their peers given the pink sheet listing. This pink sheet listing allows anyone who focuses on these weird obscure stocks an advantage over the rest of Wall Street.

No matter how good you are at fundamental analysis, the market has a way of humbling all investors, no matter how great you are. You can be the smartest analyst on a single stock, yet still make mistakes. Given the nature of the market and it’s humbling ability, I wanted to spend the rest of this letter talking about eight key things that Mr. Market has taught me.

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Illiquidity is your friend

A lot of investors fear illiquid stocks. They are hard to trade. They swing wildly in price. And once you are in, it can be hard to get out. But despite the illiquid nature of these stocks, they provide a great opportunity for investors willing to do fundamental research.

Here’s the thing. If you are a long-term investor who is willing to hold an asset through an entire business cycle, you should be perfectly fine holding onto a piece of a business that sometimes doesn’t trade. You know why? Because illiquid assets are usually priced at significantly lower valuations than their liquid peers — giving investors higher implied upside.

Don’t fear illiquidity as a bottoms up fundamental investor. Use illiquidity to your advantage to buy mispriced securities, significantly below their intrinsic value. Some of the best investments I have made have been in the most illiquid stocks.

Being A Black Sheep Pays

The stock market is one of the only places in corporate America where being a black sheep actually pays. There have been hundreds of books written on market theory that have proved buying hated securities is one of the best ways to outperform in the market. Going against the crowd works in the market. You don’t want to buy the stocks everyone loves and adores if you want long-term outperformance. You need to buy “falling knives” and boomed out securities.

Mega-caps Don’t Give Mega Returns

If you want to outperform in the market buying the biggest companies on Wall Street is not going to help. You will never have any competitive advantage against Wall Street buying the biggest, most popular companies in the world. Your competition in large and mega-cap stocks are top hedge fund managers with million dollar research budgets. You will be competing against the smartest guys in the room. If you want any chance of outperforming you need to invest where the smartest guys in the room cannot invest. These are typically the smallest, most illiquid stocks on the public markets.

Time in the market > Timing the market

Don’t try to get cute and time the market. It never works. Buy and hold assets for the long-term. When the market crashes, buy more. Buying and selling securities daily is a hinderance to building long-term wealth. Not only will you miss out on long-term appreciation, but you will get hit with short-term taxes on any gains you make.

Think like a businessman, not a day trader

Buy assets and not tickers on a screen. When you start buying businesses and not tickers on a screen, your returns will get noticeably better. You will start to underwrite all securities like you are buying the entire company out. When the market turns against you, you will have conviction to double or triple down. If you are buying tickers on a screen you will panic when the market turns south.

Fundamental Research Works, Technical Analysis is a Waste

If you are new to the market you need to spend as much time as you can learning fundamental analysis. Not only will fundamental analysis teach you how a business model works, but it can also be leveraged and used in a variety of high paying jobs: hedge funds, private equity, investment banking, etc. Learning the skills that fundamental analysis teaches you is extremely valuable and when you hone in on these skills you can become an in demand researcher. Technical analysis on the other hand has very little real world applications. No one ever buys an entire business because a chart tells them to.

Buying After A Big Win Is Dangerous

Buying a new company after you had a big win can be dangerous. Your “good” brainwaves are flowing. You think you are a genius because you just made a killing. And you have a lot of capital to deploy. After a big win in the market people tend to get reckless. They break core rules in their due diligence process. They tend to move faster when making an allocation decision. And their risk tolerance tends to go up. After you have a large win in the market take a step back and breathe. Come back to your core and humble yourself. Because if you don’t, the market will humble you from a reckless allocation decision.

Try To Focus On The Forest, Not The Trees

When you are building your models focus on the big picture items, not the insignificant drivers. A lot of smart guys become analysts because they pay an incredible amount of attention to the small details. It is a perfect job for someone with a personality like that. But sometimes when you pay too much attention to the small details you can miss the forest within the trees. Analysis paralysis is a real challenge. You need to accept that you will never have all of the information about a certain business. Eventually when enough information is accumulated you need to make that allocation decision. If all of the big picture items are pointing in the right direction but a small item that has very little incremental value to the driver of the cash flows is off, try not to focus on it. Focus on the forest, not the trees.