Motley Fool Hidden Gems Investing - Knife Juggling, Bottle Rockets, and Small Cap Investing

Episode Date: September 7, 2024

The fewer eyes on a market, the less efficient it’s going to be.  Bill Mann is the Director of Small Cap Research at The Motley Fool. He joined Ricky Mulvey to check on the small caps. They discuss: - What investors should look for in younger companies. - If Walgreens has a real turnaround story brewing. - A rapidly growing travel company out of South America. Companies discussed: WBA, SCHW, CRSP, DESP Host: Ricky Mulvey Guest: Bill Mann  Engineer: Tim Sparks Learn more about your ad choices. Visit megaphone.fm/adchoices

The place where you're going to find the multi-multi-baggers are almost always in the smallest companies. And so it is an area to fish where not as many people are fishing. And if you're looking for value, that's the place to do it. I'm Mary Long, and that's Bill Mann. He's a regular on Motley Fool Money, but in his day job, he's the director of small cap research here at The Fool. Bill joined my colleague, Ricky Mulvey, for a primer on small cap investing. They discuss why institutional investors aren't terribly interested in small companies, why

retail investors should be, and they take a look at a few stocks you may want to add to your watch list. Let's start off. Let's do, we're going to do some standard intro stuff, and then I'm going to get into the three sectors of small cap investing, at least for the purposes of this show. But I want to make this friendly to a newer investor because this isn't buying a mega cap. This isn't buying an index fund. These are rockier waters. So to the director of small cap investing, to the director of all cap investing, is that what I said?

No, you said it right. Oh, okay. To the director of small cap investing, what counts is small cap investing? Generally speaking, a company that is too small to be included in the S&P 500 would be considered to be a mid cap or a small cap. So there's no real firm definition here in the US. We put the boundary at about $5 billion in market cap and below. The smallest companies that are in the S&P 500 tend to be $11 or $12 billion. dollars. And you know what? It's interesting because we tend to think of the S&P 500 as being 500 huge companies and you've heard of all of them. I bet if you start at the top of the table and start working your way down, you don't get too far before you come across a company that you've never heard of before. But even below that, below the 500, that's when you start getting into companies that really are obscure and small and hopefully growing and becoming more successful

in some way. These are waters that most stock analysts neither cover nor really fish in. Why be these waters interesting to you? Because you want to fish where the fish are, but you also want to fish in places where you have an opportunity to come up with some sort of informational or analytical advantage. The reason that analysts don't fish in small cap waters is because they are too small. And maybe that's a bit of a tautology, but it's the same amount of effort to analyze a small cap company. And it's much, much harder for them to get paid than if a Microsoft does a secondary or if there are millions of shares traded each day worth hundreds of millions of dollars to Apple. So, you have to be in those waters. But for small caps,

you tend to see almost no one paying attention to them. And in the market, if you think that the market is largely efficient, which I do believe, the less eyes that are looking at something, the less efficient it's going to be. When you're starting to look at a company that's not getting a lot of love, maybe like Sabre Corporation, what are the pulse checks that you're doing as you start to look at one of these companies? Well, one of the things that's really important about small cap companies in general is that the management is much more important. Who is in the CEO's chair? Some of the pulses that I will do will be to really spend a lot of time and see what this person is about, what their background is, what the board looks like. Is the

board filled with a bunch of their bros? Because if a board's filled with a bunch of their bros, The board's job is to answer to the shareholders, but it's appointed by the CEO. So in a lot of ways, these businesses, it is much more important that you get a handle on what the CEO's talent level is, focus level is, and whether or not you think that they have integrity or not. And does the market cap of a company matter to you when you're thinking about allocation or position sizing, that kind of thing? Or is it more fundamental than that? I love the form of that question. It's a little bit different than how I would think about it. I would say that in terms of position sizing, it becomes somewhat of a confidence interval. Like, you're pretty sure with an Amazon that it's not going to go to zero, right? I think that that's pretty much a sure thing that in our lifetime, Amazon is very unlikely to be a zero.

That is not the case at all with most small caps. You know, the average life expectancy of a company is actually shortening, and it's 15 to 20 years. So, when I think of position sizing, I'm just doing a much more of a risk and reward, and I'm a little bit agnostic to how big the company is, except for the fact that I am recognizing the fact that I would say that the bottom end potential for a smaller cap company is unfortunately much larger than it is for the mega caps. All right. Now we're getting into sort of the meat of the show, the companies. And I've got sort of three sectors because we've talked about it before. What does small cap mean? It doesn't really get into how you define a company. And I've got sort of three ways I've been thinking about small caps. One is beaten up companies. That'll be the knife juggling portion of the hour. I've got bottle rocket speculative companies. You see quite a few of those even in mid cap, large cap land, but those exist in small cap land. And then the ones that I really like talking to you about are

just sort of the quality low key companies that are off doing their own thing and nobody's really talking about them. Let's start with some knife juggling. Is this something... Because I see so many retailers right now bill that are just getting absolutely torched and i think you know what you got to be contrarian as an investor let's run towards some dumpster fires i mean do you ever try juggling knives you like doing that as an investor oh as an investor i thought you meant actual knives uh either either take that question however you want i love it i didn't realize that that we were turning this into a knife juggling show um the the answer is yes In fact, one of the great stories that I've told many times is that my studio in my house, we call the Grand Slam Breakfast Studio, based on an investment I made in Denny's Corporation in the early 2000s when Denny's kind of forgot that it was a breakfast company and tried to push other parts of the day, and it didn't work at all.

Now, Denny's has an absolute advantage in providing cheap breakfast and got back to its core and did very well. I do like juggling knives. You've got to go in with the mindset that a lot of times the market has it right. The market has understood that this is a company that is failing. And the key to doing that very well is one, is having a sense of propriety of knowing that a lot of times you're going to turn out to lose money. But the other is that companies that actually come close to dying, but don't, there's a whole lot of value there. Speaking of companies that are coming close to dying, or at least the market seems to think so,

this is what I'm watching. I do not own stock in the company, but it is becoming kind of interesting to me. And that's Walgreens. The market cap is at about $7 billion. That's interesting because that's where it was in 1995, 1996. And it's at three times forward earnings. It's gotten beaten up on just a lot of impairment. There was an impairment charge it took on Village MD. The Goodwill impairment charge is more than the current market cap of Walgreens. You got the CEO, Tim Wentworth, maybe doing some big bath techniques through these quarters as he begins his CEO. He'll tell you a story about becoming a more focused company. And I mean, part of the thesis I'm thinking about is that this stock right now is worth less than the value of

the property that Walgreens sits on. And also Americans like prescription drugs. I feel like you buried the lead just a little bit. Yeah. But they're changing how the way they get the prescription drugs they like. So that's poking holes in it. But I don't know. Poke holes in that idea. Tell me I'm wrong, Bill. Well, first of all, I started out to correct you when you put Walgreens in as a small cap. I was like, well, there's no way that it's at a market cap that would describe it as a small cap. But the stock is down about 90% from its peak. And you mentioned 1996. That's on a real dollar basis, on an inflation-adjusted basis. This company is a fraction of what it was almost 30 years ago.

Walgreens is one of the great names in the pharmacy business. It is one of the great retailers, but they really have misstepped substantially. They had a huge write-down. They're closing a number of stores. So, it sounds to me like this is a business that has a pretty substantial chance of going straight to black. But as you said, there are real green shoots in Walgreens' business. It'll probably take a while. It is a mess right now, but I'd be willing to bet on Tim Wentworth pulling a rabbit out of the hat on this one. Yeah. I was at a Walgreens a couple of months ago and every single item on one of the shelves was just gone. And I was like, okay, shrink is still a problem. And they're not publishing shrink

numbers for this company right now. So there are still things that they need to talk about maybe before I get a little more comfortable diving in, but it's what I'm taking a look at. Any other turnarounds? And it doesn't have to be interesting from like, this is a great stock, But any interesting turnaround stories going on that you're taking a look at? I mean, to me, Walgreens is the biggest of them. Actually, not the biggest. I would say that another one that's out there is Schwab Corporation. So Schwab, last year after Silicon Valley Bank collapsed, people naturally started looking

at other banks and saying, are there other banks that have some of the same features or characteristics of the balance sheet of Silicon Valley Bank? And Schwab was one. They have a huge amount of what looks like withdrawals from the bank part of Schwab, which is actually simply people who used to just allow their money to sit in cash, didn't care because there was no real way to generate any interest on it, saying, no, no, no, no, no, no, no. In a world in which we can get 4% and 5% on our money, moving into higher interest rate vehicles than simply holding in cash.

So Schwab is a company that is, and I know we're talking about small caps. Schwab is very, very much not a small cap. Few trillion. Few trillion. No, it's not a few trillion. Yeah. Few trillion in deposits. Yeah.

So I'm answering your question literally. I can, given a few minutes, come back with a small cap. That's fine. No, we're in election season right now, Bill. So what you do, you take the question you want and then you answer it the way you want. That's right. But I think, I don't think too many listeners will be, we're going to keep talking about small cap companies.

You'll get enough of those in the show. And you know what? Sometimes a small cap company can drink its milk, grow large and strong and become a large cap company. Hopefully we'll find some of those with the language I'll use for a clean show is a bottle rocket type speculative company. These are, I think about if I'm putting,

buying stock in one of these companies, I'm I've, I've gone to a garage, I've picked up a bottle rocket. I'm trying to light it. And then there is a 90% to 95% chance this thing won't light. But if it does, if this thing catches fire, it might blow up the neighborhood. As a director of small cap research, is this a game you like to play?

We've done the knife juggling. This is the bottle rocket portion. Is the bottle rocket speculative company game one you like to play as an investor? It's funny because when a lot of people think about small caps, this is exactly what they're thinking about, companies that have the potential of becoming very, very large? The answer is that I do, but I do try to cycle away from businesses or segments of the market in which everybody believes the bottle rockets exist. Because what tends to happen is that those companies have a very, very high valuation as compared to their current revenues or their

current earnings, certainly, but a lot of times you got to look into the hereafter and it doesn't look like they will meet those expectations either. Yeah. There's a company, it's not in the outline, it's Spacetech. I think there's a lot of excitement in Spacetech and I was going to throw it at you to have you take a look at it, but then it delayed its quarterly earnings filing and then multiple members of the board started selling stock. And I was like, maybe this isn't one we want to do on the show. But I think we're seeing that in AI a little bit. I think it's starting to happen a little bit with the space technology companies, even though I own at least one of those stocks. But yeah, good point. Once people notice, there's a lot of cash flow in

there. One I haven't talked about in a while, one I haven't even talked about with you is CRISPR, which I saw you post about it on X a while back. This is one that surprised me. It is a small cap company. And it put out an FDA approved drug that doesn't treat, it cures sickle cell. And investors have kind of shrugged. So I'm not going to ask you about sickle cell treatment, but maybe on the company. Is this a company that surprised you? It kind of did what it said it was going to do. Yeah. And the really interesting thing about the CRISPR platform is that there is a not small number of therapies that are available through gene editing using the CRISPR platform. This stock is down about 75% from its high from a couple of years ago. And let's just

probably put a pin in that because its high a couple of years ago was when people were really, really excited about the CRISPRs, the editases. I don't think that they are anymore. And there analysts who believe that CRISPR is going to be profitable in 2026 and that it could earn as much as $30 a share by 2030. You're talking about a stock that's currently trading at about $48 a share. Could, would, should, those are all things that you're betting on on the come, but it is really a surprise to me that the CRISPR bottle rocket hasn't been put back in the bottle for launch. I have heard very little about this company lately, despite it getting done some pretty significant medical advances. Still, I'm thinking about this as a... I'm going to put aside

the bottle rocket metaphor. The easier thing is to say it's a VC-type bet, a venture capital-type bet, where you're thinking, you know what? This thing might be a zero, maybe a home run. Especially with these biotechs where, I mean, as an outside investor, you really got no idea. Yeah, you don't. I think probably the deal with a company like this, why haven't people paid attention? Because it's get burned once, think twice. The stock is way down. And a lot of times, investors, and it's not irrational, view the stock as being really a report card for how the company is doing, where in the reality, the stock is the report card for how people think the company is going to do. So, at any given time, all that price is, is how people feel about what is going to happen with a company like CRISPR. And I think they're not excited enough.

Let's go to the quality, low-key part of the show. I don't have a good metaphor for this one. We had knife juggling. We had explosions. This one is... Model citizens. Quality. These are the companies that are quietly in their basement working on their little train towns, creating beautiful environments, Bill, but not exactly getting a ton of attention.

One that I have not spoken to you about, I think we've talked about on the show, but we haven't talked about it much, is uh despagar which is a latin american travel company according to schwab the comparable companies are cracker barrel jack-in-the-box in bj's restaurants um i want to chat about it for a few reasons wait are you just going to keep walking past the fact that cracker barrel is uh is being uh is being compared to a latin american online travel agency yeah what you got on cracker barrel i have nothing on cracker barrel i just am having a hard time figuring out what part of its business would possibly relate to uh hotel rooms uh in lima peru i think it's a like a travel center thing the point is is that you don't have a ton of attention on it fair so when they're

listing these things on schwab they're like a travel center hospitality company we'll throw it in there with jack in the box and cracker barrel but throw it on the pile what they aren't talking about is... Actually, we'll get to the financials in a sec, because I think it's worth explaining the company before I start talking about the take rate and how it's difficult to find some information out about Despigard, despite it trading on the New York Stock Exchange. I know you travel internationally a lot. Have you used it as a customer? I have. Yeah. Specifically, when I mentioned hotel rooms in Lima, Peru, that wasn't by accident.

I thought you were... Sometimes you just pull it out, though. Sometimes you just got like a... You got something there? Okay. Yeah, fair. No, that was not an allegory. That was a fact. Okay. And I've been taking a look at it because I'm planning on going to Costa Rica in the winter. And it's pretty, even as an American, there's some competitive offerings versus your Airbnb and your Expedia. It likes packaging things more. But this is one that I've seen on your side get a lot more attention than something like Expedia. So why is Despigar more exciting? What's going on with the Latin American travel market? So Despigar does a lot more interrelationships

with the hotel chains themselves. And so it will get deals from hotels for blocks of rooms or blocks of rooms across properties or across nameplates. One of the reasons that Despigar doesn't seem to get as much attention. It was really nearly destroyed during COVID. Travel within Latin America, which was a very rapidly growing segment prior, just fell to something close to absolute zero. It also, because it's a Latin American company and it does most of its business in Latin America, it doesn't necessarily have currency risk on an operating basis, but it does have it on a reporting basis. And so, a lot of times, so like, for example, this last year, this last quarter, I should say, its revenue grew by 12%. But if you just adjust

for currency, they grew at 46%. Now, these kinds of things for me tend to revert to the mean, but people look at a small Latin American company growing at 12% and they're like, But what if I were to tell you it was actually growing much, much faster than that? Yeah. It's also, I mean, its executive headquarters is in Argentina, which does have some currency. I don't want to sprinkle it lightly. There's been hyperinflation in that country. And I imagine that could be an issue for Despigar.

Yeah. So one thing, and this is where, when we were talking before the show, you accused me of getting dense with this episode, which is probably a fair accusation. And I've been looking at the company and something, you know, something you told me, Bill, is you like to see leaders that are tied to the mast of the company. You want them to go down with the ship if that thing falls into the water. I can't find anything on the way of inside ownership. And it's OK if the answer is I can't find it either. But is that like is that unusual?

Is that a flag to you or am I not Googling well enough? No, I think you've Googled okay, but the largest insider shareholder is one of the co-founders named Martin Rastelino, and he owns about $6 million worth of the shares. Now, $6 million is not nothing, but they have not retained a huge ownership in the company. That's not something that I'm particularly excited about. I guess, on the other hand, I have not seen them selling a huge amount of shares, but the insiders do not have a substantial ownership in the company. And that's not... I guess the scientific way I would put it is, it's not awesome. Not awesome. And if you're looking for an earnings report to read, which you're at about

minute 25 of a podcast about small cap investing, maybe you are, the Despigar earnings calls are kind of wild, where if you take out currency fluctuations, we're up 40%. But there was also huge flooding in Brazil, which shut down our operations in one of our main markets for a while. So this is one, there's going to be some headaches for the company. There's a whole lot of the dog ate my homework in their earnings calls. But in actuality, in a lot of cases, it does seem like the dog actually has eaten their homework. Yeah. As we wrap up, any other companies or trends in small cap land you want to chat about? You know, I think one of the things I really do encourage people to think about small caps as

an area of investment, particularly as companies, there's so much concentration at the top of the market. I mean, which is not to say that the NVIDIAs of the world aren't awesome companies, But the place where you're going to find the multi-multi-baggers are almost always in the smallest companies. And so it is an area to fish where not as many people are fishing. And if you're looking for value, that's the place to do it. As always, people on the program may have interest in the stocks they talk about. And The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear.

I'm Mary Long. Thanks for listening. We'll see you tomorrow.