Chit Chat Stocks - Mastering Microcap Investing With Whit Huguley of River Oaks Capital

Episode Date: February 26, 2025

On this episode of Chit Chat Stocks, we talk with Whit Huguley of River Oaks Capital on all things microcap investing. We discuss: (11:01) The Importance of Due Diligence (21:41) Idea Generation and Research Process (32:42) Suggestive Investing and Capital Allocation (37:58) Understanding Margin of Safety in Micro Caps (39:01) The Importance of Suggestive Investing (43:54) Innovative Food Holdings: A Case Study (49:00) Management Impact on Microcap Success (01:03:16) Navigating Portfolio Management and Position Sizing RIVER OAKS CAPITAL WEBSITE: https://www.riveroaks-capital.com/ ***************************************************** JOIN OUR FREE CHAT COMMUNITY: https://chitchatstocks.substack.com/  ********************************************************************* Sign-up for a bond account at Public.com/chitchatstocks  A Bond Account is a self-directed brokerage account with Public Investing, member FINRA/SIPC. Deposits into this account are used to purchase 10 investment-grade and high-yield bonds. As of 9/26/24, the average, annualized yield to worst (YTW) across the Bond Account is greater than 6%. A bond’s yield is a function of its market price, which can fluctuate; therefore, a bond’s YTW is not “locked in” until the bond is purchased, and your yield at time of purchase may be different from the yield shown here. The “locked in” YTW is not guaranteed; you may receive less than the YTW of the bonds in the Bond Account if you sell any of the bonds before maturity or if the issuer defaults on the bond. Public Investing charges a markup on each bond trade. See our Fee Schedule. Bond Accounts are not recommendations of individual bonds or default allocations. The bonds in the Bond Account have not been selected based on your needs or risk profile. See https://public.com/disclosures/bond-account to learn more. ********************************************************************* FinChat.io is The Complete Stock Research Platform for fundamental investors. With its beautiful design and institutional-quality data, FinChat is incredibly powerful and easy to use. Use our LINK and get 15% off any premium plan: ⁠finchat.io/chitchat  ********************************************************************* Bluechippers Club is a tight-knit community of stock focused investors. Members share ideas, participate in weekly calls, and compete in portfolio competitions. To join, go to ⁠Blue Chippers and apply! Link: ⁠https://bluechippersclub.com/ ********************************************************************* Disclosure: Chit Chat Stocks hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Learn more about your ad choices. Visit megaphone.fm/adchoices

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Now, please enjoy this episode. Welcome in. This is another edition of the Chit Chat Stocks podcast. My name is Brett Schaefer, joined as always by Ryan Henderson. But today we have a fantastic first-time guest, friend of a recurring guest, John Rotonti. We appreciate him connecting us today. It is Whit Hugley of River Oaks Capital, the founder of River Oaks Capital, an investment fund that focuses on small and micro cap investing. We're going to get into, as you can kind of tell with the title of this episode, how to invest in micro caps, how to do it successfully, and the ways that River Oaks goes about it. So, Witt, welcome to the show. As we get into things, why don't you just take

us through your personal history a bit and how you got started with River Oaks Capital? Yeah, sure. Thanks so much, and thanks for having me on. I appreciate John introducing us. John and I have become good friends. We're both from New Orleans, and I watched y'all's most recent episode. I thought it was great. And I know he's been on multiple times, but super excited for John to connect to us. I think probably the easiest way to tell how I got to where I am today of running River Oaks Capital is just to start all the way back from after I graduated college. I worked for a startup company here in New Orleans and I worked there for about four or five years. Became really fascinated in what it took to grow businesses, what it took to

go from one employee to 20 employees, 20 employees to 50 employees. But along the way, I realized I really needed more background in finance and just a more business acumen. So decided to go back to Tulane here in New Orleans and get my MBA. And, you know, I went back with the goal of starting my own company once I graduated, like a venture-backed type company. And I think it was the first semester I took an investment analysis course. We read The Intelligent Investor, which is somewhere over my left shoulder here. And I read a bunch of stuff by Warren Buffett, and I was just totally hooked. And it was almost immediately my direction in my career changed. It was like on a dime. It was that inoculation you hear Warren Buffett and other value investors talk about.

So I'd say that year, I read maybe 50 books on investing. I just could not get enough of it. I ended up getting my MBA and CFA at the same time and moved out to California to work in private equity. And, you know, looking back on it, I got super lucky with my private equity opportunity. It was a pretty large private equity fund, but the deal team itself was not very big. So I got to do anything and everything. I got to visit management teams, do financial analysis, go to conferences, visit competitors. You know, I really got to do, you know, everything that you would want to do as far as on the private equity side. And, you know, what I really learned when I was doing this is that there's so much more behind investing than just a 10K in auditive financials.

I really learned the human element side of investing. And, you know, I'll get into it a little more in detail later. But the other thing I was really picking up on is we were investing in what would be considered micro cap and small cap public companies, micro cap, but they were obviously private. And we were buying anywhere from 30 to 50 percent ownership most of the time. So the management teams were staying when we bought ownership in these companies. So it was very similar to an analysis you would do when you were buying a public company as well. But I was really starting to pick up on that almost all of our most successful investments, there was an A-plus management team involved. And, you know, I'll kind of get into that later.

But, you know, we would just obviously if you're going to buy a company for five, 10, 15 years, you do extreme due diligence before you buy this company. We would meet with management team multiple times. We'd go into every conference that involved that sector, talking to every competitor, talking to any industry expert. And I think what was really drilled into me by working in private equity, and I think I've put this quote in a ton of my letters and said it many different times, but the Warren Buffett quote that shares are not mere pieces of paper. They represent part ownership of a business. So when contemplating an investment, think like a prospective owner. And that's really that was really drilled in my head that you're not buying a ticker symbol on the public side. You're buying owner part ownership in a business, even if it is one percent of a company or less often.

But so on the weekends when I was working in private equity, I was investing family and friends money in the public markets. And, you know, naturally, I was investing in micro cap and like the smaller end of small cap companies, like anything under a billion dollars of market cap, because that was the size of the companies we were investing in on the private side. And I just noticed how inefficient those smaller companies were on the private side. And I was shocked to discover that, you know, in my opinion, they were even more inefficient on the public side. And obviously, I didn't have the bandwidth at the time to do the extreme due diligence because I had a full time private equity job. but you know so this would have been you know starting about a decade ago i started private in private equity eventually in 2019 i moved home here to new orleans and um i moved back home to new orleans and launched the fund in 2020 and um you know what i was really surprised about

is right when I launched the fund, it was just already in my DNA to do the extreme due diligence that we were doing on the private equity side. So, you know, I talked about it in my most recent letter, but, you know, I had done a ton of work on this $100 million micro cap company. And, you know, before buying ownership,

it's just, you know, within me that I want to go visit the management team in person. I want to see the headquarters. I would just see everything, talk to the competitors, do everything we were doing on the private equity side. So I flew out to visit the management team. I'm all nicely dressed, super excited, and a little nervous, have all my questions written down. And I walk in, and you can just tell they're staring at me like, what are you doing here? You're the first person to visit this company in five to ten years.

So I had a pretty quick aha moment that this is how I could provide value to my investors. And, you know, I'm an investor in River Oaks Capital as well. So to myself as well, and was just by doing the rigorous due diligence in micro cap public companies, just because, you know, I would just I slowly found out that very, very few people were doing this. And there's no analysts covering these companies. So it's not as though I'm asking questions that are non-public information. It's just questions that have never been asked to these management teams because no one has ever been there and no one's ever covered these companies. And, you know, so, I mean, the way I think about it is if here in New Orleans, if I was to buy a 10% ownership in a local restaurant, I wouldn't just read the financials and then just buy 10% ownership in the local restaurant. I would want to go meet the management team.

I would want to go see what the other competing restaurants are like, see the other owners of the company. you know, I would do a much more rigorous due diligence than a lot of people do before they just buy stocks. So, I mean, that's really the core of, you know, the first aha moment I had is that, you know, we are buying ownership in the company, even though in private equity, it might've been 30 to 50%. And at River Oaks, it might be 1% of a company still treated as if buying the entire company and doing that due diligence. So hopefully that at least gets you up to speed of how I started the fund. Yeah, it's very helpful. And we hear investors all the time say, oh, we take a private equity approach to public markets. But with small cap

investing, it really is even that much more amplified where you're not, it's that much more important to know management and to really treat it like ownership. Whereas you can maybe get away with it in some of the larger companies and it's probably harder to access management for most people as well. Let's dig in a little more to your sort of due diligence process. Once you've actually, I kind of want to start with your idea generation before we even get into the research process. Where, are there any common places that you are generating new ideas? Yeah, I think probably the most interesting thing about micro or not the most interesting thing, but the thing that makes it quite difficult is that they are very hard to screen for.

There's always something quirky within the business. You know, there might be some something on the balance sheet, some asset they own on the balance sheet. Just there's always very infrequently. Is it just like a clean? OK, this is trading at five times earnings. It's generating a 20 percent return on free cash flow. It's very hard to screen for. So for me, I've developed a network of other micro cap investors that I bounce ideas off of. I go to conferences, you know, I but I would say most almost all the idea generation I've had is a from just traveling around, visiting other companies, asking them about their public competitors. And, you know, once I find an idea that I think is super attractive, I'll reach out to about eight to 10 other of my micro cap

investor friends and say, hey, I just found this attractive idea. And then they're willing to share an attractive idea they found. And then, I mean, you can also just do it through brute force to just going A through Z through the OTC markets and, you know, the lower end of the NASDAQ market. And, you know, that works as well. It's screening I've had almost no luck with. It just it doesn't it's just not clean. It's not like larger companies. So that's really where the idea generation comes from. But then, you know, going into the second part of your question about the due diligence. Yeah. So, I mean, you know, as I said, you know, it was just in my DNA to immediately, you know, before I bought ownership in a company, I wanted to visit the management team in person.

I wanted to deeply understand the industry. I wanted to get to know all the competitors. I wanted to talk to the other major shareholders. And, you know, and I just quickly realized, as I already mentioned, that this was something that basically no one else was doing or very few investors were doing. And, you know, I think this provides value to my investors in one of two ways. I mean, the first way is, I guess you could say provides value. You see you screen the company. It's trading at five times earnings or it's 50 percent of book value. you're ecstatic to buy ownership in the company.

You can't believe how cheap it is. And you get on a plane and you go visit the management team. And within five minutes of the visit, you realize this company is totally uninvestable. They are solely concerned about their salary, the board fees, and then what happens with the rest of the free cashflow of the business, they care very little about.

They're just not aligned with investors at all. And unfortunately, this is a large part of the micro cap of micro cap companies. And you can kind of get away with it because there are no eyeballs on the company. You know, a company that I visited that no one else has visited in five years, they could probably expense things through the that they aren't supposed to expense, raise board fees. um so i think the first way it provides value is just kind of getting rid of those companies that you should never invent you you would have a zero percent chance of ever making a good return but and you know for me personally the only way i can diagnose that is by meeting these companies in person even a phone call i have trouble diagnosing it and i certainly

I think maybe some people can. I certainly can't diagnose it by reading the financials or even the proxy statements. So I think that's the first way that it provides value to my investors. The second way is the example I often use. I think it was about four years ago, I got on a plane and flew to Fort Worth to have barbecue with Dayton Judd, the CEO of FitLife. And within five minutes, I realized this guy could run a fortune 500 company. He was just head and shoulders above almost every management team I had ever talked to. And, you know, I mean, also included he owned 50% of the company, but I mean,

what, I mean, so that's really how I feel the second way I could provide value to my investors, is getting on a plane and finding these undiscovered gems. Because once again, by reading through the financials of FitLife, I mean, it was trading about seven to eight times earnings at the time, but it had a really rocky past. And Dayton had come in and taken over the company in 2018 and just completely turned it around. But you really couldn't see that turn around yet in the financials. You could see that it was turning around, but it wasn't until I met Dayton. I was like, oh, this has the potential to be an absolutely incredible investment.

And the way I really diagnosed that is when I sat down with Dayton, I mean, A, he knew the business like the back of his hand. He had the most control over the business I had ever seen numbers wise he had a long-term plan in place but b he was just talking to me owner to owner business owner to business owner he was saying here's what we do good we're great at cutting costs we're great at acquiring competitors that have too much debt or bloated um costs um and then he was like but we need work on um our erp system we need work on the cfo side you know he was just saying the pros and cons of investing in the business and FitLife. And most of the time when you when I had visited with other micro cap management teams, they're just giving a sales

pitch to me, we're going to be the next Tesla. We're going to 100x from here. And, you know, when I sat down with Dayton, I get four years ago, he was it was the exact opposite. He was speaking to me as if, you know, I was a business owner, which I was, and he was a business owner. We were just speaking the pros and cons of the business. And, you know, I probably only come across a Dayton type CEO one to three times a year, if that, but it really makes all those flights worth it when you can discover just an uncovered gem like FitLife, which has had an incredible return since we bought ownership in the company and you know I think Dayton is one of the best capital allocators I've ever come across and you know he was just kind of

hidden in this small company and it really made all that traveling I do and all the hard due diligence worth it when you find a company like FitLife. At what point do you decide all I want to go meet with management. I think a lot of people are – I read your letters and I think – because just generally speaking, hard work is kind of something that's like hard to quantify, I guess, in investing. Like what does hard work look like? I'd say buying plane tickets and getting out there and trying to meet these management teams is a lot of what hard work is. And it seems like you really exemplify that in your letters. But if I were an individual investor, I might think, well, I'm a little worried this might not be worth the plane ticket. So at what point do you decide it's time for me to get on a plane and go try to meet management? Yeah, that's a great question because it's definitely been a learning process.

At first, I was getting on planes probably way too quick. um just wanting to visit any and every company um that i thought was underpriced um now what i now what i do is once i've read through the financials gotten to deeply understand the business um talk to other investors who might already be in the company that i know um you know i've developed a nice network of really knowledgeable investors at this point um i have zoom call with the management team um and it's pretty quick i mean i i maybe part of this is experience or maybe part of this is just the fact that there's very few a plus capital allocators in microcap um public companies but it's pretty quick um during the zoom call that you know okay

this is worth hopping on the plane for um and you know that's certainly come with experience of doing this for i guess if you include the private side as well doing this for over a decade now um but you know at first i definitely jumped on a plane too quickly now i'd say most of the time when i'm going to visit management team of management team um i'm already 75 of the way there that i think they're going to check that a plus capital allocator box and then i'm more going to just ask questions and more deeply understand the business. The diagnosis, especially of a management team that you don't want to invest in, is not very hard in microcaps, if I'm being honest.

And the diagnosis of an A-plus capital allocator is a little harder, but I've gotten a lot better at knowing, okay, this is time to now jump on a plane and go meet these people in person. One of your other topics or one of the other things you look for or part of your strategy is, I think this name's good, you call it suggestive investing. What is that? And how can it help your investors and the management teams yeah so i think i mean going back to um an a plus capital allocator i think that's like important to kind of step back and talk about what that is and i think you know as i said there are few and far between in micro cap small in the smaller into small cap public companies i'd say there's maybe 30 to 50

in the entire universe. And I think, you know, Jim Collins, I'm not sure if you've read the book Good to Great, but he qualifies leaders of businesses as one through five, five being the highest. So a level five leader, which I would call an A plus capital allocator, he says has the leadership style is characterized by a powerful combination of personal humility and professional will, meaning they are highly ambitious for the organization's success, but with a modest self-effacing attitude, prioritizing the needs of the company over their own personal gain. So, I mean, first and foremost, you know, we're not going to buy ownership in a company that doesn't have an A-plus capital allocator alongside of it, unless it's

just an extremely one-off deep, deep value situation. But going back to your question on suggestivist investing and why I brought up the A-plus capital allocators is what I've noticed is some of these A-plus capital allocators are incredibly good at running the day-to-day operations of their business. They're incredibly good at reinvesting cash back into their company whenever there's areas of above market return rates that they can reinvest their cash in. But some of the companies we own, not, I would say only a handful of them,

some of them are perfectly allocating capital back to our shareholders. But some of them will build up cash on the balance sheet that's unnecessary, have non-core assets on the balance sheet that are unnecessary. And, you know, what I realized was just because microcap markets are inefficient now, you know, if you look at the valuations of microcap companies compared to the S&P 500 or even private companies, you know, it is it's extremely inefficient. And some of that's warranted, as I mentioned, some of these companies are uninvestable, but there are some undiscovered gems in there.

And, you know, so what I realized is just because those companies, the wonderful companies we discovered are inefficiently priced now doesn't mean that they can't remain inefficiently priced for five to 10 years, or in fact, they could get even more inefficiently priced. So that took a lot of learning the hard way for the first three years of the fund, especially. You know, I started to learn, you know, I really started to learn that, you know, just because a company is undervalued doesn't mean someone is going to come find it and bid up the share price. So the suggestivist investing I do is really all geared around towards making sure that my investors can generate a 10 to 15 percent return per year for kind of to just throw a ballpark number out there. if the share price doesn't ever move. And the way they can do that is by buying back shares. That's the preferred method, increasing dividends. And then there's obviously one-off situations

where it will be a growing company where it makes way more sense to reinvest all the capital now back into the company so that once they reach a mature stage, they can pay a larger dividend or buy back more shares. So what I was observing is that a lot of these microcap companies were getting frustrated by the fact that their share price was undervalued. And instead of being frustrated, I thought, you know, it makes a lot more sense to capitalize on this opportunity. There is no other area in any public market where you're going to find an opportunity where there's a wonderful business trading at 50 percent of fair value. So if you buy back shares of that business, you're basically turning one dollar into two dollars immediately.

and there's really it's just such a layup capital allocation opportunity that instead of getting frustrated you know the management teams should be taking advantage of and so what I've been doing the last two years really I'd say maybe it started two and a half years ago is when you know every year I try to visit the management teams or I do visit every year the management teams of companies we have ownership in and talk to them quarterly. And, you know, I guess I can give you a tangible example. Recently, I visited a company we own that had $50 million of cash on the balance sheet, right around there.

And what they were trying to do was acquire another company. And the acquisition price looked like it was going to, they hadn't yet acquired a company, but it looks like the acquisition price was going to be around 10 times earnings if they were to acquire another company. And their stock was trading at five times earnings. So I flew out to visit management team, and actually another major investor came with me. And, you know, we gave them a pretty quick pitch of,

instead of buying another company at 10 times earnings, why not buy a large percent of your ownership or a large owner large percent ownership in your company at five times earnings and you know you could just see it kind of slowly clicking in their head that yeah that probably doesn't make more sense and a week later they announced the share buyback program um so i've been pleasantly surprised at how receptive a lot of these management teams have been to buying back shares. I think part of it is the fact that a lot of these companies we've owned for almost five years or over five years now for some of them. So they know I'm not suggesting this to just get the stock price to bump so that we can

sell the company. They know that this is what I think is best for long-term shareholders. and um i mean what really changed my mind is a company we own medical facilities you know for the first three years of running the fund i had this thought in my mind microcaps are super illiquid um so it's going to be really hard to buy back shares um it's just a pain and maybe it does make sense to build up cash on the balance sheet or just pay out a dividend in. And over two years, medical facilities, which is only a $200 million or sub $200 million market cap has bought back 50%. There's on pace to buy back 50% of their shares. So it's really changed my mind that if you want to, if you roll up your sleeves, you can go out and buy back a ton of

shares in micro cap companies. And sometimes it requires getting on the phone and calling literally calling large shareholders or doing a Tinder offer. There's various unique ways you can do it, but that's really the gist of my suggestivist investing. By no means am I trying to be confrontational. If that was ever a situation, I just wouldn't buy ownership in the company. By no means am I telling them the way to run their day-to-day operations of the business. If it was a bank, I wouldn't tell them you should be lending to this person or anything of that nature. What I've noticed is that, as I've mentioned, some of these micro-cap teams are great at running the day-to-day business. They're great at reinvesting capital

into the company, but could use suggestions of what to do with the excess cash that's being generated by the company. All right, listeners, we've got a new sponsor here at Chit Chat Stocks, and their name is Blue Chippers Club. Blue Chippers Club was recently started by two friends of ours with the goal of building a tight-knit community of stock-focused investors. Inside this community, everyone gets to share and break down their portfolios, pitch stocks, receive feedback, and participate in weekly calls. We truly love this idea, and it's why we're promoting it here on the show. In fact, we are in this community ourselves and enjoy just how much value we get by collaborating with other investors. If you're interested in joining,

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description. Yeah, that is a difficult one where I think you find it in large caps, mega caps. You find it all over the world basically any type of stocks the capital returns while seemingly simple to us that's i guess that's kind of what we're you know looking at all the time is maybe something that gets overlooked quite a bit and is a simple thing that you can go after now the fourth topic that you looked at the one that you kind of sent over is about your philosophy is margin of safety I think people, listeners, are going to be extremely worried about margin of safety in microcaps. You know, stuff can go to zero. You have things that maybe are overlooked.

You know, you're not investing in Amazon and Google here. What do you look for in a margin of safety? Is it balance sheet? Is it management team? How do you analyze that and help protect the downside for your investors? Yeah, I think it is. I always knew it was important because, I mean, I think Warren Buffett always suggests reading, I believe, is Chapter 20 of The Intelligent Investor, which is all about margin of safety. Seth Klarman rewrote, you know, I would say a modern version of The Intelligent Investor that's all about margin of safety.

So I always knew it was important. I didn't, I'm really discovering how incredibly important it is. Because in micro caps, maybe it's just because this is the area I invest in, but it seems like there's a disproportionate amount of unpleasant surprises that happen. And I mean, that's just the nature of doing business. You know, businesses are run by human beings, we're all going to make mistakes. And that's just the nature of what's going to happen. So, you know, what I'm really looking at is free cash flow to equity yield. And, you know, if they have excess cash on the balance sheet, great. And, you know, your margin of safety, I require less of a margin of safety if it's just an A-plus capital allocator like Dayton Judd. But even then, I want to be buying it at 65 to 70 cents on the dollar. And then, you know, for some of these lesser quality companies, 50 cents on the dollar. And, you know, I think what I've discovered and, you know, what I've written about is, you know, two mistakes that we definitely made were two companies, both BBs and Galaxy Gaming, where kind of worst case scenario happened to both.

And in BBs, we were actually able to make about a 30% return in a year. And Galaxy Gaming, we got our money back. And, you know, what I realized is microcap markets are really the only area, at least in the U.S., in public markets where a company can go down 30% for reasons totally unrelated to the underlying business. So if you deeply understand this company better than anyone else and it goes down 30 percent, you could get on the phone, call the CEO, just make sure, OK, I'm not missing anything. I mean, obviously, there's only so much they could tell you, but I'm not missing anything here. You just know that it went down 30 percent because of some for seller. Like, for instance, in Galaxy Gaming, there was a large shareholder who owned, I think, 5% of the company or maybe 3% to 5% of the company. They went through a divorce.

One side of the divorce decided the next day to sell all their shares. So it's really the one area in public markets where you're able to average down on your cost basis and increase your margin of safety without anything materially negative happening to the company. And that's the only reason we were able to generate decent returns on BBs of Galaxy Gaming is we were averaging down at times when it just went down 30% to 40% on a four-seller. And yeah, so to answer your question, margin of safety is extremely important, especially in microcaps. And I'm really thinking of it, you know, wanting to buy even wonderful companies at a five to seven P.E. ratio. And then you'll oftentimes like, for instance, certain community banks we own had more more cash on the balance sheet than the entire market cap of the company. You can find some areas where there are extreme margins of safety. but um at the same time you're you're probably gonna be there's gonna be a disproportionate

amount of mistakes as well because that's just the nature of small businesses um so i mean i think that is bb's a galaxy gaming are good examples of how you can average down along the way basically worst case scenario can happen and um you could still come out all right um you just got to make sure that when the stock price does go down, that you continue to buy ownership. And, you know, also the second part I'll add is just avoiding debt. Companies with debt at all costs, almost every micro cap company, or at least a vast majority of them are going to have variable debt. They're going to have not great covenants and you can get in trouble real quick. So looking for companies that have zero debt as well, and I would include that as part

of the margin of safety. So you can kind of get that original Ben Graham style, okay, I got half times book value, I have really clean balance sheet here, and that's what can, you know, if the suggestive investing the management stuff the business quality doesn't turn out like you think well that balance sheet can help you you know not have a position go to zero yeah yeah and i think suggestive investing is important if they're buying back shares as it's going down averaging down is incredibly important as long as it's you know on um information that's in material to the company but yeah you can find some significant um companies that have significant margin of safety i

mean going back to fit life i think when we bought it it was trading at five times earnings which is just um an extremely cheap valuation once you get get to deeply understand the business so i think you know if you're hopping on planes going to visit management teams deeply understanding the business and have an adequate margin of safety, you can make some pretty phenomenal returns in micro caps, but there's a lot of risk out there as well. All right. We want to get into one of the companies in the River Oaks portfolio, but before we do that, I guess I have one question on this suggestivist strategy. When you're looking especially for them to start allocating to buybacks, I guess my first question is, why are they typically not doing it, or not to the degree that you think they should? Is it just them being so focused on the operations that they don't think about it? And then the second question is, what does that look like? Is that like you just pitching their own stock to them, essentially?

Yeah. I mean, yeah, to get the first part, I think they're so honed in on the operations of the company that they're just not thinking about what's the most efficient way to return capital to a shareholder. So oftentimes they'll be paying a dividend. And if they're trading at 50% of fair value, it's like you can literally double your dividend by buying back shares here in the long run. and yeah it really is as simple as pitching um pitching their own company back to them which

is a little bizarre thing to do but um yeah it's the example i gave you um and i've done it for for probably um five companies out of the 15 that we own where i'm going to them and i'm saying you even using conservative valuation metrics here, you're trading at 50% of fair value. And unless you think there is some capital allocation opportunity out there that's going to generate 20% to 30% returns on invested capital, I think it makes the most sense to just buy ownership or acquire your business at five times earnings.

um and once again i've been pleasantly surprised at how well that's gone because i think you know i've written about in various of my letters but due to passive investing and various other reasons um microcap markets seem to be getting perhaps even more inefficient um or at least staying as inefficient as they are um and you know i think that will change eventually. But in the meantime, I'm just trying to really push for them to capitalize on this inefficiency instead of getting frustrated over it. Because I really think that you can generate a 10% to 15% return for all shareholders by just buying back your own stock. And that certainly is not the case for most mid-cap and large-cap companies. They're buying back their stock at

15 to 20 times earnings. And just because it's more tax efficient than paying a dividend. Here, you're buying back stock because it is the best capital allocation decision you can make. And that's really the pitch I've given. I think it's helped a lot that, as I said, I talked to each management team that we have ownership in once a year or visit them in person once a year talk to them once a quarter so i developed a deep relationship with a lot of these manager teams so it's um you know it's they know that i'm pitching it for the right reasons and almost every company we own um they own a large percent of the company too the management team and the board um so it's you know it's a win-win situation for everyone um yeah i hope that answers

your question. Oh yeah. That's, that's helpful. I do want to move to one of the companies in your portfolio. It's called Innovative Food Holdings. Maybe can you give a little bit of a synopsis on a brief description on what the business does and how you came across it? Yeah, sure. I think, yeah, I think it's super important to understand the industry before you can really understand innovative food holding. So the food distribution industry, much similar to many distribution industries, is divided into two categories. You have broad line distributors, and that is dominated and consolidated by three major competitors, Cisco, U.S. Foods, and PFG, which are the trucks you see driving up and down the highways, and they're delivering food to

everywhere you consume food except grocery stores. Grocery stores have their own separate distribution channels. So I guess the best way to think about Cisco, US Foods, and PFG is they're the Walmart of food distribution. They're going to deliver you the bulk things a restaurant needs rice beef you know all of that type of stuff and then on the other side you have specialty distribution so the example i use is there's a farm in michigan called ham sweet farm and they sell grass-fed lamb um and it is it's um you know it's just not worth the time of cisco U.S. Foods or PFG to develop a relationship with a grass-fed lamb farm that doesn't sell in bulk or anything of that nature. And that's where these specialty distribution companies step

in. So typically, the specialty distribution companies are local. Like in New Orleans, here in New Orleans, they would have a specialty food distributor that only delivers to New Orleans restaurants and cafeterias. And it's very fragmented. It's almost the exact opposite of the broad line distributors. There's one per city. And that's really where Innovative Food Holdings steps in, is they're really the only nationwide specialty food distributor. um there's um you know there's chefs warehouse but that's that's still even more closer to a broad line distributor than a specialty distributor so what innovative food holdings will do is they'll go to a customer like ham sweet farms and they'll say you know instead of um selling your

grass-fed lamb just to Detroit restaurants, we can plug you into a nationwide sales distribution channel where you can sell your grass-fed lamb to every restaurant throughout the U.S. by FedExing it overnight. And the way they've done that is by developing relationships with the broadline distributors. So if a restaurant orders grass-fed lamb from U.S. Foods, let's say, that gets fulfilled. The order gets sent to Ham Sweet Farms, and the lamb gets sent to that restaurant. And that restaurant thinks that it has ordered that food from U.S. Foods, but it's actually been fulfilled by Innovative Food Holdings. So they have a really win-win situation pitch that they can give where they're going to the local mom-and-pop organic lamb farm and saying

instead of selling locally, we can sell your product nationwide. And then they're going to the Broadline distributor and saying instead of being the Walmart, we can give some depth to your food catalog to every restaurant so that the restaurants can order not only the bulk rice and the beef and whatnot, they can also order specialty items through you as well. So that's really how they've created a win-win situation and have really started to dominate this fragmented market. Finchat.io is the complete stock research terminal for fundamental investors. They have robust financial data on more than 100,000 stocks globally. That includes more than 10 years of income statements, balance sheet, cash flow, and

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No card required. Again, that's FinChat.io slash chitchat. The link will be in the show notes. I see the stock price. It was at, I'm just kind of looking at a random place on FinChat here, 20 cents maybe in 2022. Today we're at over $2. What happened? I hear management had a thing to do about it.

I think this is a good example maybe. of how management can be very impactful in microcaps. Take us through that story. Yeah, sure. So I think it was about five years ago, the prior management team decided they wanted to get into e-commerce and sell gourmet cheese

and also like food delivery kits online direct to consumers' houses, customers' houses. So they weren't selling to restaurants, They still had the core business, but on the side, they had this e-commerce business that was going from warehouses directly to people's houses. It wasn't going to restaurants or anything of that nature. And over five years, they lost $12 million doing this. And it just became a complete disaster. And I'd say it was about two or three years ago.

Actually, a good friend of mine, Denver Harris, who's a large shareholder, started to write, I guess, activist letters, for lack of a better word, just pretty much saying, you've gone astray focusing in on e-commerce here because they also had to buy warehouses as well for these e-commerce businesses. So it turned an asset-light company, you know, the delivery of ham sweet farms to a restaurant, all it takes is FedExing overnight. There's no capital involved at all. And then it took an asset-light business, it turned it asset-heavy, and also took an e-commerce business that was losing $12 million a year. So eventually, an activist campaign started. The board basically completely turned over. James Pappas became chairman of the board, who has a deep, deep expertise in the food industry. Jeff Graham came on the board, who is well known for shareholder activism, for lack of a better word, and Denver Smith. And then there's a few other board members as well. But the board now owns 50 percent of the company.

And, you know, the major move was bringing in the new CEO, Bill Bennett, about two years ago when the share price was, what you read, 20 cents per share, right around there. And Bill comes from a corporate background. He worked at Walmart, a few other places, SC Johnson. His last place was Kroger. um so you know i think at first there's always concerns about someone with a corporate background coming into a micro cap company that is more entrepreneurial and eat what you kill for lack of a better word in nature um but the reason bill was leaving kroger is for for that exact reason he wanted to either get into a startup company or get into a situation where he could eat what

he kills and um so what he's done since taking over has been truly amazing i mean first things first he did he did the obvious of divesting the e-commerce business getting rid of the non-core assets they had they had a warehouse in pennsylvania pennsylvania so he sold that that warehouse but you know when he stepped in to the business what he saw was a this was probably the best or most shareholder-friendly micro-cap board throughout all of micro-cap companies. The top three, the three board members I mentioned all have funds. They have plenty of capital if they needed to reinvest in growth. But B, he saw that the core business was actually extremely um had quite a um good bones as he puts it um and you know he you know he from his deep expertise

already being in the food industry he's like this core business really has some value here um so once he they divested the e-commerce business um reduced headcount um reduced uh every check that was going in and out the door the first year bill bill um looked at he you know he gave the example that they were paying three hundred dollars to cut the lawn of some place there was a tiny little lawn and even that he reviewed and cut cut the uh cut out so he completely revamped the business and and the last piece he did was also raise prices which was um You know, you'll notice when these A-plus capital allocators come in to micro-cap companies, such as Bill, which I would 100% classify Bill as an A-plus capital allocator. It actually reminds me a lot of Dayton Judd at FitLife.

There's a lot of low-hanging fruit that they can get rid of quick. And they had on the, you know, the good bone side of the business, the asset light delivery side of the business, they hadn't raised their prices that they were charging since inflation had happened. So, I mean, that was just a simple fix of, all right, we're not really raising our prices. We're just catching up. You know, they were still charging 2019 prices, not factoring in the rampant inflation that had happened. So, yeah. So Bill returned it back to its core business. And I mean, really from there, it's gone from a turnaround story to really starting to grow nicely again. And, you know, where I stepped into the investment was I got to know, I met Bill in person about a year ago, got to know him quite well, was exchanging phone calls. I realized, you know, this guy was one of those 30 to 50 A-plus capital allocators that are out there in the microcap industry.

But I was still kind of sitting on the sidelines watching the turnaround story to see how it happened. And I think it was, I guess, four or five months ago, the board reached out and said they were trying to raise capital and they were interested if I was interested in participating. And that's how I was introduced, I guess, although I already deeply understood the business, that's how I was introduced to investing in the business. And the reason they were raising capital is that that iGourmet business that I talked about where they were delivering specialty cheese directly to people's houses, they shut that down. But they had this large Pennsylvania warehouse that was unused. And Bill was able to go out and sign an enormous contract with a top five retailer in the U.S. to be the sole specialty cheese distributor for that retailer. So what he did was he turned a mistake that the prior management team had made into an incredible opportunity that's going to generate tens of millions of dollars just this year. So what they needed to do is they had to raise capital to get the equipment to cut this cheese. and um so i think the last part worth mentioning is as bill was just assessing the business he

noticed prior management team had done one acquisition that was quite interesting it was called artisan foods which is a local specialty distributor um the ones i've talked about that are all throughout the u.s that just distribute to certain areas of the market and it was a local specialty distributor in Chicago. And they had acquired that business about 10 years ago. And what happened was when they acquired that business, they were able to step in and immediately or almost immediately double the sales of the specialty distributor because they could take the 1,000 items the distributor was selling throughout Chicago and plug it into the the nationwide sales channel that they had through U.S. Foods, Cisco, and PFG.

So that's really where you're going to see the next stage of growth, and it's already happening as Bill and the Innovative Food Holdings team has acquired a specialty distributor, well, actually two specialty distributors in Colorado, Golden Organics and Loco Foods. They're both for very reasonable acquisition, very reasonable prices, about three to five times earnings. But, you know, they're both I think they're both making around six million dollars in revenue. But once they plug that into their national sales catalog or their national sales distribution, they should be able to double the revenue because both Loco Foods and Golden Organics were only selling to the Denver area. And now they're able to take those products and sell them throughout the entire U.S. And so the short-term goal Bill had when he took over two years ago was to get to $100 million in revenue and $10 million in EBITDA.

When we invested, the market cap was about $75 million. The share price has obviously gone up quite a bit since then. We invested $1.60 a share. Um, and it looks like by the end of the year, Bill will hit that a hundred million in revenue, um, through the acquisitions, um, through growing the, through growing the business through broadband distributors and also through the, uh, specialty cheese gourmet, um, relationship with the top five retailer. Um, so, I mean, what he's done is he is completely in six months from now, or at least by the

end of the year, this business is going to be unrecognizable from when he stepped in two years ago. It's going to have over $100 million of revenue. They're going to uplist onto the NASDAQ next quarter. They're going to be debt-free because they're going to sell. They only use a fourth of their Pennsylvania facility. So they're going to do a sale lease back there, use the use those proceeds to pay off debt they'll have five to six million of cash on the balance sheet to then go acquire other specialty distributors similar to the one that they did in um in colorado recently and i think what's super exciting here is that they've just returned to the asset-wide nature of the business so i mean to give you an example of how growth

how quickly this company could grow. They recently signed on a new Broadline distributor, and they only had to hire one employee. So there is virtually zero CapEx that's required to grow the delivery side of this business. So I think that's really what the margin of safety here is, is that, you know, earnings could significantly grow. You know, I think by the end of this year, they'll have six to seven million of free cash flow. And I think, you know, that could easily double without any reinvested capital into the company

or very little reinvested capital. On top of that, you have the most shareholder-friendly board that I've come across since I started the fund five years ago. And that owns 50% of the company. And the chairman of the board, James Pappas, his family owns a lot of restaurants throughout Texas. I think there might even be a few in Louisiana. And he's on the board of quite a few food-related companies. So they're going to make the most logical decision for us shareholders going forward, too.

It's just, it is a really well-aligned situation with an A-plus capital allocator that is, I think it's a theme that I didn't really get into much here, but I think what makes it super interesting when you find these inefficient niche markets like specialty distribution, if you plug in an A-plus capital allocator like Bill into these markets, almost always their competitors are going to be C-minus management teams that are just trying to collect a 9-to-5 salary. They don't really care about what happens with the excess free cash flow or they're not. So someone like Bill can just run circles around the rest of the management teams in these industries. And, you know, you're going to see him start to acquire a lot of his competitors at three to five times earnings. I guess they're not even competitors, but specialty distribution companies are three to five times earnings. And the situation is developing nicely, and I'm super glad that we were able to invest quite a lot of capital all at once about five or six months ago. You mentioned earlier that you try to find situations in the small cap world where you don't need necessarily that multiple re-rating to generate a good outcome.

But if that does happen and you do get some multiple expansion, how much leash do you give the companies that are in your portfolio that are doing well, but the multiples expanding is a little uncomfortable because you're kind of like juggling the forward returns with the success you've had so far and how good the business is? I guess, how much leeway do you give those companies? Yeah, that's a really good question. I think out of all the investing books I've ever read, which is hundreds by now, I think, I've never heard a good answer of when to sell. I've never really heard like this, a formulaic type approach of when to sell. But for me, you know, what I think about is I always want to be holding companies, ownership of companies that can continue to generate a 10 to 15 percent return for my investors going forward. So I have a list of three reasons I would sell a company.

And the first reason is the valuation gets so high that it would be a disservice to my investors not to sell you know it's just even if they hit a home run we would only get a five percent return going forward um the second is if it turns out the management team is is dishonest or just incapable but mostly dishonest and the third is if they just take a complete left turn if if we invest in a company that does restaurants and they say actually we're going to start building water parks from here on out, if they, you know, just completely changed their mind. So that's the three reasons. But yeah, I think your question's super important and something that I'm always trying to keep

track of is, can we generate at least a, you know, 10 to 15% return going forward, even if the business has significantly increased in price? So, you know, if you think of a company like FitLife, you know, that I keep talking about, But it's increased about close to 100% since we bought ownership. But I think the intrinsic value of the company has increased 100% as well. So it's, you know, it's very much monitoring how much the price of the company has grown versus how much the intrinsic value has grown and looking at the returns we could generate going forward. I'm not, you know, like a never sell person. If it gets to a valuation that's crazy high, I will gladly move on to the next idea.

All right. I think that wraps things up. But I have one final question. Maybe Ryan can add some if he has as well. Portfolio management, position sizing. I think we bring it back, you know, to the broad micro cap discussion. maybe it's different than someone that's investing in these large caps or maybe it's an obviously different than index fund investor how do you do portfolio management position sizing

how many positions do you like to run with cash position maybe take us through you know some bullet points there yeah so i got super lucky here um this guy who i would i guess i consider and my mentor at least or my sparring partner someone that i can exchange uh thoughts and ideas on is dave's hugh evans he ran the microcap fund um for tiro price for 30 years and um ended up moving back to new orleans um a couple years ago and you know we definitely talk about companies that i've been that i'm considering investing in but this is the subject that we talk about by far, that him and I talk about by far the most, is thinking about position sizing, thinking about, you know, how many companies to have in the portfolio, that, you know, that type

of, I guess, portfolio construction. So for me, I almost always have 8% to 10% in cash. And, you know, if a COVID-like situation happens, I'm more than happy to bring that down to below 5%. But it helps me sleep easier at night having 8% to 10% cash. Going back to what I mentioned earlier about the margin of safety, we could capitalize on those times when micro-cap companies are indiscriminately sold off for reasons unrelated to the business. um so i always like to have about eight to ten percent cash um you know i i foresee going forward the the fund always having 10 to 15 companies that's kind of just where i feel comfortable with and 15 is about the max of uh management teams i can keep up with personally per year

um visiting and i feel like there's plenty of diversification at 15 companies if anything i could see it getting closer to 10 companies as we continue to grow. And as far as position sizing goes, I think, you know, there's obviously certain situations like we bought ownership in Citizens Bank three years ago, I think. It's a community bank where it had more cash on the balance sheet, way more cash on the balance sheet than the market cap of the company. So it was literally every branch of the bank could have closed down and we would have still made an incredible return. So something like that, I'm pretty comfortable going up to 15% rather quick in the fund. And 15% is more or less where I cut it off. But the way I think about it is my most heavily,

something that's 15% is something that has extreme downside protection. So the highest weighted companies in the portfolio are the ones with the most downside protection where I just I feel like even in the worst case scenario we would at least get our money back and then when I'm thinking about companies that are more on a growth trajectory such as innovative food holdings I kind of buy a little slower um and that was definitely a mistake I made early on where I would get super excited about a company do a ton of work and feel like well since i've done all this work i need to make this company at least 10 of the portfolio um and for innovative food holdings right now it's about six percent of the portfolio and you know obviously unfortunately the price has run up about

35 since we bought it but as i sit back and continue to watch watch the growth progress I have no problem making that 10 to 15 percent of the portfolio, but that's going to be in slower increments. So that's how I'm thinking about it is when you just have like a Ben Graham type citizens bank and opportunity that I talked about. I have no problem making that up to 15 percent of the fund just because I don't I don't think there's any way aside for an asteroid hitting or something like that that we're going to lose money. um for something that's more growth a little more growth oriented a little more reliance on the future um i'm more slowly buying ownership and that that's been a progression i've made over the last five years i used to kind of do the opposite and then they would miss a quarter or something would happen share price would go down and i wouldn't have enough cash to continue to buy

ownership so um you know with uh companies that have more the growth is ahead of them or the growth is more in the future i tend to more slowly buy it but i'm still all would be fine in the long run having um innovative food holdings be 10 to 15 percent of the portfolio yeah it's something we've talked about here as well and maybe learned about is if it's a growth company If it's something that thesis has to develop over time, the company can almost make it into, you know, they can, by their stock price, by the business performance, tell you that they deserve to be a larger position in the portfolio, but maybe at the beginning, not so much. All right. Appreciate it, Whit. Thank you for taking the time today to join us.

Where can listeners find you and more information about River Oaks Capital? Yeah. I really appreciate it, Brett and Ryan. That was a very fun conversation. And I've always enjoyed listening to your podcast. I've been listening to it quite a few years now. I think you actually pitched a couple of stocks that I bought ownership in years ago. But I think the easiest way to find me is just on our website. It's riveroaks-capital.com. If not, you could just find me on Twitter at my name with WHIT, last name Hugley, H-U-G-U-L-E-Y, which will have a link to the website in the bio. Or feel free to email me at whugley at riveroaks-capital.com. All right. And the River Oaks Capital website will be in the show notes for anyone who wants to check that out, but as well, quick Google search.

should help that as well. Let's hit the disclosure. We are not financial advisors. Anything we say on this show is not formal advice or recommendation. Ryan and I are any podcast guests, may hold securities discussed in this podcast, may have held them in the past, and may buy, sell, or hold them in the future. Thank you to Witt for joining us. Thank you to the listeners for tuning in once again, and we'll see you next time. Thank you.