Another Way to Beat the Market?

June 2023 Newsletter

In my quest to beat the market, I am always searching for new ideas that could give me an investing edge.  You can find these approaches anywhere such as in print, podcasts, Youtube and books.  I recently read “100 Baggers: Stocks that Return 100-to-1 and How to Find Them”, by Christopher W. Mayer.  It’s not entirely a new idea, as it’s basically a modern reinterpretation of an older work by Thomas Phelps.  Effectively it has the same messages but uses modern data and more recent company case studies.

The book has a few interesting themes that I believe are useful for the small investor.  Finding and owning a 100 bagger is difficult for a number of reasons but not impossible.  You just have to look around at all the big names like McDonalds, Apple, Amazon, Microsoft and Monster Inc. as examples. They were all small companies at one time and if you bought them early, they eventually all became 100 baggers or more.  The book demonstrates what to look for based on the commonalities of 100 baggers.  The recipe for 100 baggers is quite simple in practice, but very difficult to achieve at the portfolio level.  So let’s set out the recipe as outlined in the book:

Small: 

You simply cannot get a 100 bagger out of Apple anymore – it’s just too big.  Small companies are where you are most likely to find the 100 baggers.  So how small?  Anything with a valuation of under $1 Billion is where to look.  Besides being small they generally need to be well run, high quality, with some kind of moat to ensure a longterm competitive advantage.

Fast growing:

You cannot achieve 100 to 1 without growing year after year at a fast pace; we’re talking 25% growth per year or more.  Also there should be no dividends; the earnings must all be plowed back into the company to keep compounding the growth.  Growth is a little funny, growth in earnings, sales, free cash flow are all fair game when evaluating a potential 100 bagger.

Inexpensive valuation:

If you pay too much for growth, it’s not going to work.  In fact, the author says the key to a 100 bagger is to combine high annual growth with an increase in what the market is willing to pay for that growth in the future.  In other words, low price per earnings is necessary at purchase, followed by higher price per earnings in the future. It’s these two factors that mathematically combine to create the potential for a 100 bagger.

Skin in the Game:

The author notes that a large proportion of 100 baggers have an owner-operator with a significant ownership stake.  This is not unusual and has been covered in other books like “One up on Wall Street” by Peter Lynch.  In fact, there are funds that invest in only owner-operator companies and for the most part, they tend to outperform the market.

Time:

So the last piece that ties the approach all together is time.  It requires a buy and hold approach that is quite long – we’re talking decades.  Within the book there is much discussion about the “coffee can” approach to investing: buy a good company, sock it away, and forget about it. It’s similar to the way people saved money in the olden days, before electricity and flip phones.  The idea was that when you made a dollar, you hid it in an old coffee can in the kitchen, and did that for years till one day you could retire.  A non-anecdotal example is the Voya Corporate Leaders Trust. It’s a fund established in 1935 that invested in the biggest companies of the time.  As part of its design, the fund could not purchase or sell any stock after its inception.  This is the true meaning of buy and hold.  The fund has beat the SP500 since 1935!  It still exists! Interestingly, some of the companies within the trust died over time, but others kept growing or changed by way of mergers, splits and other deals. The point of this chapter is that ‘Buy and Hold’ as a concept is very powerful, because it removes the human need to interfere due to fear or greed.

What do I think of the book?

There are a few good recommendations, like the buy and hold approach as well as the owner-operator advantage.  Where it falls short, and the book does allude to this problem, is that few investors have the ability to do a 20-year buy and hold strategy.  Even if things play out in your favour and now you have tripled your money on a small risky stock, there is an argument to sell off some and lock in profits.  It’s a nice problem to have, do not get me wrong, but even from a portfolio management perspective, you cannot as a small investor tolerate a position that represents 25% or more of your portfolio.  It’s just not prudent to have most of your wealth caught up in a speculative position.  In addition, small companies are generally more volatile, even big companies like Amazon went through huge up and down cycles in the beginning, which would drive any investor to lose sleep or go mad.  Surely emotion would end up prevailing, resulting in a sell after a big run up in price or a big fall.  The reality is that its really hard to follow a potential 100 bagger to a hundred.

Probability is another problem as it relates to small companies.  Lots of small companies run out of money and die for all kinds of reasons. About 80% of small companies don’t have positive earnings and are less able to deal with adversity than a giant well capitalized company.  Picking the right company, even after you know all this, is difficult and against the odds.  In other words, any stock picks resulting from copying this approach should end up in the speculative area of your portfolio.  My speculative positions only comprise of around 2-3% of my total portfolio. It would make no sense to try and invest all my savings in an attempt to land 100 baggers, because the likeliness of striking out is relatively high.  That being said, if you happen to get just one right, you may have a life changing situation…if you can manage to hold on to it to the end.

What is the small investor to do?

I always find something of value in reading books and this one is no exception.  It has made me think that I should be more serious about my speculative positions.  Generally, I just react to events in the market.  It’s more of an entertainment activity than a strategy.  It would be interesting to buy a few small companies and see what happens, understanding that some could end up dead.  As I have always said, there is room in a portfolio for some speculative positions.

Portfolio Update

The portfolio YTD is up 15%. It’s a good return but it is now lagging the SP500 benchmark by (2.34%) after having been ahead for a while.  It’s a weird market with only a handful of sectors doing well.  These are Information Technology, Communications and Consumer discretionary at 40%, 35% and 33% respectively year to date performance.  The other 8 sectors are seriously underperforming the SP 500 17.34% YTD average return.  Worse for small investors is that even within the winning sectors, there are a small number of big players that account for all the gains.  Chances are good that most investors are lagging this year.  You need to be lucky to be in the right sectors and the right companies.  

A good indicator to judge the market is to look at the Invesco equal weight ETF, symbol RSP.  This ETF is basically the SP500 index without the weights, so that every company is equal to Apple, or Amazon.  The YTD performance on RSP is 7.65% which is about 10 points less than the weighted market index.  It demonstrates how your average companies are doing and not just the biggest ones.  Luckily my portfolio happens to have a few of the big winners like Amazon, Apple, Google, and Netflix .  I am also overweight in communication sector stocks (which is part of my Bear strategy).  Nevertheless I am slightly lagging.  It’s a good return, but behind the market just the same.  Another reason for underperformance, which I have not verified yet, is that that the Canadian market is really lagging at 4.5% YTD.  My portfolio, although mostly American, does have a few Canadian positions, which is likely not helping.  If your portfolio is all Canadian, you’re likely having a bad year.

Looking Forward

I still think it’s a weird market and that there are a lot of reasons why the year may finish up well, as I alluded to at the beginning of the year.  We are already above an average return which sounded like a crazy forecast back in January.  Could we push 20% by end of year?  Why not? That is an average bull market return.  You must remember that the long term market average of 10% is comprised of big positive bull years and big negative bear years.  It’s rare that we actually see the average.

Marc’s Monthly Moves

• No buys or sells this month.

Marc’s Portfolio YTD Performance

• Portfolio return:12.5 % (including currency losses)
• Portfolio return: 15% (without currency losses)
• S&P 500 return: 17.34%
• TSX: 4.5%

The portfolio under performed the S&P 500 by 2.34 percentage points.