We Study Billionaires - The Investor’s Podcast Network - TIP607: Small But Mighty: Uncovering Smallcap Value w/ Paul Andreola

Starting point is 00:00:00 You're listening to TIP. In today's episode, I'm talking with Paul Andriola about how we evaluate small cap stocks, why flipping over as many rocks as possible uncovers the best winners, why to put all your focus on profitable growing businesses to both increased returns and decrease risk, why the price to earnings growth ratio is so important for finding great opportunities, the importance of understanding the capital raising process, why value will always succeed in the long term, the current state of microcaps, and much, much more.

Starting point is 00:00:30 Ever since speaking with Paul on the millennial investing podcast back in August of 2023, I've become good friends with him. He's reached out to me and shared numerous great ideas and has happily shared many of his investing strategies with me at a very deep level. He's been a sort of mentor for me and I feel a lot smarter every time we talk. Paul's knowledge, experience, and passion for microcap investing are hard to beat. He understands the discovery process at a whole different level than anybody I've found. And his entire system for leveraging his knowledge has produced some incredible picks.

Starting point is 00:00:58 His greatest pick of all time was finding Expell back on it was trading around 20 cents. As of February 2nd, 2024, it's trading at $53.80. And this just scratches the surface of his ability to find multi-beggers. Paul's told me he's previously identified five additional hundred beggars that are boring but highly profitable businesses. If you like learning about multi-begger stocks, especially ones that have smaller market caps, this is a must-listen conversation. Additionally, if you own a smaller private business and are thinking of one day going public, you will learn a lot about how to generate institutional interest.

Starting point is 00:01:31 Now, let's get to my conversation with Paul Andriola. Celebrating 10 years, you're listening to the Investors Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now for your host, Kyle Greve. Welcome to We Study Billionaires. I'm your host, Kyle Greve.

Starting point is 00:02:07 Today, we bring Paul Andriola on to the show. Paul, welcome to the podcast. Hey, good to see you, Kyle. We spoke on the millennial investing podcast back in my first ever episode with TIP, and I've earned a heck of a lot about small caps since that interview. So today, I wanted to get into the weeds a little bit more about your strategy with small caps, from the buying process to monitoring your businesses, to figuring out what to sell. So to kick it off, you like getting your small cast business at a discount.

Starting point is 00:02:32 After all, you publish a buy annual report for your subscribers called Cheapies with a chance. So let's start here and discuss the evaluations you look for in potential investments. Okay, well, first off, we start by flipping over as many rocks as we can, the old Peter Lynch adage. And what that means is we go through Cedar Filinges up here in Canada. And there's 2,700, roughly 2,700 public companies. And we have a certain criteria we look for. And predominantly the criteria really fits best for, sort of call it the small caps or even nanocams. We're looking for companies that, A, are profitable, right, which will distinguish themselves significantly from a lot of the other, you know, small companies that are out there.

Starting point is 00:03:13 But then there's other factors that we look for it. And typically, we're looking for things that are sort of growth in nature, right? We want to see small companies grow into big companies. That's where, you know, historically, or at least my experience, I found the biggest value is in finding these misprice growth opportunities at a small scale that the institutional investor or, you know, sort of the, the bigger investor cannot participate in it even if they recognize it, right? So we're trying to find

Starting point is 00:03:41 those characteristics that, I'd almost describe it, you know, that a fund manager will buy, but can't because it's too small. And that's growth, that's profitability. That's, you know, there's some other factors. There's capital structure and things like that. But the big driver is growth

Starting point is 00:03:57 in profitability. If you can just find those type of companies, you've really, well, A, you've gotten rid of about 85% of the rest of the market. But you're finding those companies that have that potential that really turn into major, major win. And I know that you like, obviously like you just mentioned, because the institutions can't enter into the fray here, you obviously get these massive mispricings.

Starting point is 00:04:21 So because you are dealing with smaller ones, do you have any specific parameters that you use in terms, let's just say in terms of PE or say, you know, enterprise value to earnings that you won't go above? Like, are you always looking to try to stick below a certain number or how do you view that? Well, not really. Like, look, a faster growing company deserves a higher multiple. So what we're really looking for is less sort of a defined number in terms of price to earnings. We're looking for what we call a PIN ratio.

Starting point is 00:04:51 So a lot of people would know what that is, a price earnings over growth ratio. So the faster growing company deserves a higher multiple, right? So I've done very well buying, you know, stocks that are trading at 30, 40 times earnings. If those companies are growing at 100% or more, then you can justify that. And then there's companies that you could buy at eight times earnings that are declining in revenue. And I wouldn't touch those because that's a melting ice cube as far as I'm concerned. So you have to be a little bit more flexible.

Starting point is 00:05:20 And quite frankly, the good ones, you know, the hyper-growing companies tend to get a higher evaluation anyway if people are properly paying attention. So yeah, I use a pay ratio, which I can talk to if you want, that that's really the driver in terms of what we think something's cheaper now. Yeah, would you mind just going over a quick case study using the peg ratio for the listeners to better understand it? Sure. I'll give you a real world example of a company that we found called mid last year in thermal energy. I think you might even know it. So here's a company that was growing at about 70, 80 percent a year. And, when you look at its earnings, you could model up pretty quickly to see it was trading at about

Starting point is 00:06:00 10 to 12 times earnings. Some might think 10 to 12 times earnings is not super cheap, but when you sort of layer in the fact that it was growing that fast, you've got a peg ratio that is sub one, like significantly sub one. Anything below one is typically viewed as inexpensive and anything above one is considered expensive. So what you do with the peg ratio, and there's two variations of it, you take the rate of revenue growth.

Starting point is 00:06:29 Okay, the actual, the real version is you take the rate of earnings growth on a per share basis. So if a company's earnings is growing, it's, let's say 100% a year, it's doubling its earnings every year, and the stock is trading at 20 times earnings, you have a 0.2 peg ratio, and that would be considered cheap. Now, what we do is we actually take a little bit even more. conservative approach. We take the revenue rate of growth and then use that as the factor. So if we do that, what tends to happen is your earnings growth rate is usually leveraged so it grows even faster than that. So if we can find something that's growing its revenues at

Starting point is 00:07:05 60% a year and trading it 20 times earnings, then we know we've got an extra buffer because likely that earnings is growing at 100, 150% a year. So that's what we look for. And because we go through all the companies out there, we can sort of rank all the different. companies against each other. And what we're trying to do, and this is what we do with the cheap piece of the chance, is we're trying to find the best or the cheapest based on a peg ratio. And then we add in the fact that if we can find something that's sub-50 million dollar market cap, we know that it's even likely more misprice or more, or call it, less discovered. So that's what we do. And, you know, you just describe the cheapest of the chances.

Starting point is 00:07:46 So I know that you just talked about how you like to go and look at every single business in Canada each year. And so I know in mid-2023 you said that the exact number was I think about 14% of the businesses in Canada were profitable. Now, I know you've done, I think you're working on one right now. So I'm not sure how far long you've come. But can you share what number of Canadian businesses right now are profitable? Is it the same thing or is it higher or lower? It's roughly the same. It's been an interesting market over the last several years.

Starting point is 00:08:18 Typically what happens is when the market gets healthy and frothy, you get a whole bunch of new companies that come in, right? Companies that are a little bit more speculative, they're looking for capital, they're newer businesses, and they're not as likely to be profitable. So you start to get that number ballooning and the percentage of profitable companies actually goes down. Now, the flip side too, and kind of what we're seeing right now is some of the really good profitable companies are actually getting bought out. So that's slightly driving the number down as well.

Starting point is 00:08:50 But historically, the number doesn't vary too much. So yeah, it's roughly the same as what we saw mid-mid last year, around that, well, it's 13 to 15 percent of all the companies list in Canada are profitable and that we take a subset of that because we want to find profitable companies that are growing as well. So one of the major issues that investors have with small caps is that many have very short histories from which to form conclusions. So to decrease risk, I think many investors just simply stay away from microcats specifically because of this factor. From your history in small caps, what have you noted are the biggest risks to an investment going south and how do you minimize the impacts of these investments? That's probably the most important question an investor

Starting point is 00:09:31 has to ask themselves is really what's the downside and what's the risk. I can talk about how we mitigate our risk when we're buying these small companies. First off, look, if you're buying a profitable company, you've really, really significantly de-risk that investment opportunity, right? I'd almost go back and say almost every major mistake I've made was in expecting too much of a company that wasn't profitable. And so if you're looking at de-rissting yourself as much as possible, stick with profitable companies. That it also sort of, it mitigates the financing risk that's possible as well. And there are kind of two different things you guys. got to watch you for. One is risk of failure to the business. So that means, yes, of course,

Starting point is 00:10:16 a proper company will still have risks and you may end up with, you know, a competitor that comes in and just kills them or a regulatory change or something that you can't really foresee. That's sort of a standard business risk that you, it's very hard to prevent. The biggest thing you do to sort of mitigate that is buy with a big margin of safety, right? So if you're buying it cheap enough, you're kind of mitigating that business risk that's so hard to predict. But if you're buying a company that likely has to finance, especially if it has to finance to keep the operations going, that's where you add a high degree of risk. And we call it dilution risk or financing risk, and we try to avoid that at almost all costs. Now, if markets are good, if capital markets are healthy, then yeah,

Starting point is 00:11:04 they can keep going back and raising money. And as long as that opportunity is still there, they're fine, right, or at least the business is fine. The problem you have with that, though, is it's diluting your ownership of the business. It's not necessarily a risk to the company is going to go to zero, but it completely dilutes your ability to see a significant gain, right? So if you're constantly getting diluted, it almost prevents the upside from materializing, right? So I've seen a lot of experience.

Starting point is 00:11:34 This happens a lot in the mining space where you see these companies, you know, they go from a $20 million market cap to a billion dollar market cap, but the prices never moved. Like if you were a shareholder, you've never made any money, even though the value of the business is growing. And that's because they've issued millions and millions of shares. So for us, what we want to do, it's like anything. You want to de-risk everything you participate in and still maintain upside. So for us, we look for profitable companies. That takes away that risk that something could materially go wrong quickly and all of a sudden that they're out of the business. You know, we watch for the balance sheet. You know, obviously you have to, you know, you want to

Starting point is 00:12:14 see a balance sheet that call it healthy. Debt is a four-letter word. You got to watch out for debt. And, you know, if a company has taken on too much debt, that clearly increases the risk. But so if we're happy with the balance sheet, then it really becomes a function of if it's profitable, what are we paying for? And the bigger of the margin is. safety, the more risk we've taken out of the equation. I really, really like your takes on financing because it's not something that you hear talked about a lot, and I know you know a lot about it and you've researched it a lot. So you recently wrote, quote, going back to the market for funding can be very expensive.

Starting point is 00:12:51 For instance, raising one million in shares is not the true cost of financing. When conditions are challenging as they are now, you can get bad shareholders who know they have the upper hand with a company that serially dilutes, selling and driving down the share price. There's also considerable cost involved among the leadership team who spent significant time hunting for money. Then there's commissions on financing, legal and accounting fees, sweeteners like warrants, an IR firm, and more. The result could mean getting a bad price on new share issuance requiring even more shares and excessive number of warrants, which means even more shares. So in a perfect world, you'd probably just love to see a business that can self-fund its day-to-day operations as well as its growth, if that's the direction it's going in. But since that luxury is often reserved for a lot larger and mature businesses, I'm interested in knowing what your general strategy is for assessing specifically the funding in specific businesses and understanding what's a good situation versus what's a poorer situation.

Starting point is 00:13:45 One thing that we look for and we think is vital to any company that's, well, I'd say any company, period, but more importantly to small companies and especially companies that are likely going to have to go in finance is you want to see somebody ideally on the board of directors that has capital markets experience. And ideally, they have a vested interest in that company, meaning they've got a lot of shares in that company. And why that is is because the capital markets or the financing part of this industry is cutthroat and it's deadly, right? If you don't know what you're doing and you're going out there raising money, you will get scalped like you wouldn't believe. So you need to have somebody on that board that understands the dynamics of the industry

Starting point is 00:14:27 and knows what a good deal looks like and what a bad deal looks like and how to go and get a good deal when you're going and raise money. So having that helps out quite a bit because you're right, the cost of going out and getting money is not just the commission that gets charged. Typically, there's a discount to the trading price. It can be upwards of 20 to 25%. A lot of times I have to add sweeteners like warrants and broker options, and there's a number of other things. And yes, it's costly for management to have to go out, especially if they have to do this

Starting point is 00:14:59 on a regular basis. You're taking away from the operations of the business. So all of these things are factors that come in. And all of a sudden, when you sort of kind of do the math, from a shareholder standpoint, yeah, okay, they're raising a million bucks. Yeah, maybe they paid 7% in cash commission. So theoretically, you're getting 93 cents on the dollar. But it's being done at a 20% discount to where your shares are.

Starting point is 00:15:22 And the management team is taking their eye off the ball. And they may have lost the customer because they were spending their time getting this stuff done. You also get, if anybody sniffs a financing coming, you tend to see the stock price get hit. And usually when a company is going out to raise money, they've got to go and test the waters. So the minute they test the waters, the potential for that sort of news to leak is out there. And that's when you start to see the real pain as a shareholder that they're going to have to suffer because of these financing. So it's never black and white, right? There's always way more cost.

Starting point is 00:15:58 And again, a reason why we try to avoid those type of situations as much as we can. Let's take a quick break and hear from today's sponsors. All right. I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future. That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all

Starting point is 00:16:34 over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful main stage talks, hands-on workshops on freedom tech and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June.

Starting point is 00:17:21 If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedom Forum.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just the conference, it's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately. How do we make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move.

Starting point is 00:17:55 With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR, and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NetSuite AI connector, you can use the AI of your choice to connect directly to your real business data.

Starting point is 00:18:30 This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, Demycifying AI at netsuite.com slash study. The guide is free to you at netsuite.com slash study. NetSuite.com slash study.

Starting point is 00:18:55 When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters. For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S. from brands just getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch

Starting point is 00:19:31 of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance your product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support. Start your business today with the industry's best business partner, Shopify, and start hearing Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right.

Starting point is 00:20:12 Back to the show. So one thing I've noticed with a lot of these nanocaps is the bit, you know, when they, kind of when they're in their infancy and they're, you know, not profitable at all, they are going to the markets and issuing equity to raise funds. for their growth. But then a lot of them, the successful ones, the ones that you are looking at, become profitable and they're able to kind of just eliminate, or maybe not fully eliminate, but heavily decrease the amount of share issuance that they need in order to grow. I'm interested in understanding more about the inflection points here, like what are the capital markets or,

Starting point is 00:20:43 you know, banks looking at from these nano-cat businesses that will allow them to get more comfortable with them actually giving the money rather than just taking shares in the business. The nice thing is when your public company, you've actually gone public likely to go and raise money, right? Equity capital. What you want, though, is you want as many options as possible to go and raise money when you need it. And the problem is, you know, until you're able to prove to the bank that you can actually pay that money back, they're not likely to give you any debt. So you're stuck with this situation that I can't go talk to the bank until I'm cash flowing and making money

Starting point is 00:21:19 because otherwise they're just either going to charge me an arm and a leg or they just won't give me the money. So you need to see companies that actually have the wherewithal to pay back that cash. Then the other key thing to remember is, okay, now what is the bank actually lending against? I've been involved in situations where if it's a software company is very difficult to get a bank to lend money because there's no hard assets, right? You're basically, the collateral is an income or revenue stream that if it disappears, there's nothing less. to go and chase, right? Whereas if it's a company that produces hard goods or needs machinery or things like that, there typically is an asset they can collateral ties. So you've got, let's say you've got this piece of machinery that's generating revenue and something goes wrong,

Starting point is 00:22:05 you know, that revenue disappears. The bank or the lender can go after that asset. So it kind of depends on the type of company. If you're a company that has hard goods that you can use as collateral, then you're more likely to get debt even before you're cash flowing, whereas a software company, you're unlikely to get debt until you're cash flowing. So those are the things to look for. Now, you still have to have proper capital allocation. Somebody in the business has to sit there and say, okay, yes, we can get bank debt, but our share prices are so high that it makes more sense to actually do equity or vice versa.

Starting point is 00:22:41 So you don't want to just go and get bank debt because it's there. And sometimes you don't want to just go get equity because it's there. You got to know how to work a calculator, right? You got to know how the results will be if you take on that type of that kind of capital. So you said before, quote, none of my 10 plus beggars ever started out of swans. They were all some form of ugly ducklings. Learn to love microcaps with fixable problems, unquote. So this is an awesome quote.

Starting point is 00:23:07 And it's somewhat at odds with what Warren Buffett famously said, which is, you know, turn around seldom turn. So I'm interested in learning more about what potential problems microcaps face that you think are the easiest and most value of creative problems for shareholders and people in management to solve. I'd never like to say I'm disagreeing with Warren Buffett. But actually, I think so we don't actually buy a lot of turnarounds, right? We buy companies that have something wrong with them, but typically it's something wrong with the optics or maybe even the capital market side of things, right? I'm not a huge fan of turnarounds. I'm a huge fan of companies that have hit, you know, maybe they've struggled over time,

Starting point is 00:23:45 but they've actually fixed that thing and now they've hit that inflection point. Most of my, you know, swans were companies that, you know, had to really, really struggle for a period of time and then somehow found something and it clicked and things started to go. I can go back in all my major wins. I know they had some struggles, right? So we're actually looking for things that are more optics, right? So why is this company not trading properly? Why is it not trading the valuation it should? And it's usually, maybe they have an extremely poor IR. Maybe they have a balance sheet that

Starting point is 00:24:20 looks ugly because of some of the legacy issues, but their income statement is fantastic. Maybe they've had to change management and now this new management has righted the ship. Those are things that they're all great, but they show up in the financials. They show up in that sort of criteria that we look for. And yeah, you might say they, they, they, they basically have already gone through their turnaround. And now we're just able to buy at a discount of price because the market hasn't figured that out yet. A friend of mine's got, you know, Mahmoudan has got this term he uses. It's information arbitrage. We just found that information before somebody else did and we can put in place and put a value to it. Yeah. And I know that a lot of,

Starting point is 00:25:02 like just I've looked at a lot of the businesses that you've looked at too. And a lot of times it's not necessarily even, yeah, they don't see my turnarounds. It just feels like they've, maybe they've gone through some unnecessary or short-term headwinds, right? Like COVID, for instance, was a big headwind for certain businesses. And, you know, then they get punished for it, which maybe it's fair. And then now that COVID's over, they're kind of unleashed again. But the market, like you said with that point that they don't realize things quite as fast, especially in these microcaps, they just don't see it. So you can definitely find some incredible opportunities there.

Starting point is 00:25:35 Exactly. Exactly. That's exactly what we look for is that, you know, companies that were sort of wrongly put in the penalty box, we, you know, we try to identify when they're coming out. We jump on it as soon as again. So in our first chat, you discussed averaging up

Starting point is 00:25:49 and you really emphasized how much you love doing it. One of the examples that you used was Bowflex, which is now Nautilus as an example that you should have been buying even more of, even as a price increased. So for some value investors listed, they might be horrified by the concept of increasing their cost basis on a stock.

Starting point is 00:26:06 But I'm interested in getting a better understanding of when and why averaging makes sense for you. Exactly. I've got the experience of doing it the wrong way to work from. Really, what you're trying to do is you're trying to always have an understanding what you think the value of the business is and trying to buy it below what that value is. Now, if it's a growing company, that value theoretically should continue to increase, ideally,

Starting point is 00:26:33 along with the price, but sometimes the price doesn't properly match it. So what you're doing is you're trying to make sure you still have that margin of safety as that value is growing and that share price is either growing with it or perhaps not growing fast enough to meet value. So we're constantly measuring that. We don't blindly buy just because it's going higher, but if the value is increased significantly and we feel there's still that margin of safety, we're in there. continue to buy. Now, the thing to be careful, too, is that, like, we have to measure that against all the other opportunity costs that we have, right? So we're going to look at that opportunity. And if it's looking fantastic and still better than anything else we can find, then

Starting point is 00:27:18 that's the impetus to continue to add to that position. If it's growing and the share price is going up, but we're finding something that's better, then we're unlikely to add to that position. And so when you're, when you are averaging up, I assume it's the same kind of thing. I guess you just updating your peg ratios and if the, you know, if the PE is low enough, but then the growth is still high enough, then that's kind of where your opportunity is? Yeah, usually when we get heavily involved in a company, we're going to really understand it well enough. So some cases, you know, we've seen it recently with another company, the allowance of contract, for example, and we'll be able to really understand quickly how much that contract is going to impact the value.

Starting point is 00:27:57 And if we think the market hasn't properly responded to that, that's going to drive us to be buyers again. So it doesn't necessarily have to be at their parole rate every quarter is showing up and it's higher and we're waiting for that. We'll see other potential value drivers that we're going to jump on. And a big part is because we understand the business so much and we know that, look, if they land a $2 million contract, what kind of impact should that have on value? That's what we do. We really get under the hood and understand what's driving it and buy when we think it makes sense. And what's the most you'll average up by cost basis in one position as a percentage of your entire portfolio. You know what, there's no set, like what I find that the best investors out

Starting point is 00:28:35 there don't have sort of preset parameters around that sort of stuff. What they do is they look at every case on a case-by-case basis, right? So if all of a sudden, some company has doubled its value based on some material event, that shouldn't prevent you from dramatically increasing your percentage ownership. Now, especially if you have the confidence that that's the best opportunity for you out there, Right. Again, the exercise that we go through of looking at so many companies gives us comfort that we're ideally buying the best four or five opportunities that we think we can get our hands on. And if there's a change in the value of that business, it shouldn't have, well, based on my experience, it shouldn't have that much of difference in terms of what you decide to do with

Starting point is 00:29:20 it in your portfolio. What's it called? A recency bias or agency bias. No, that's not a used to buy us. But because you own 5% of that company or 5% in your portfolio, if all of a sudden it's the most obvious opportunity for you, you have to go and increase your position in a material way. You can't sit there and say, no, I already own my 5%. I can't buy any more based on that rule. It's just like the best investors in the world don't do that. I mean, again, Warren Buffett, I mean, there's so many examples of him in that adage, you know, when it brings gold, you don't put out a thimble, you take out a wheelbarrow or a bucket or whatever you want. So I know that you aren't a huge fan of averaging down in the majority of circumstances.

Starting point is 00:30:02 You wrote a really good analogy why that is. Quote, if you personally lent someone money and they only repaid you half of what they owed you, would you give that person more money? Of course not. Yet we continually do this with our investing where we average down into things that have a history of disappointing us, unquote. Since many of the businesses that you look at are often overlooked for extended periods of time, it would seem that averaging down can sometimes make sense if the business

Starting point is 00:30:24 This is increasing value at a quick rate, but the price has decreased. So I just love to have your thoughts on averaging down and when you think it is, it does make sense. You're right. We rarely average down. Now, we do try to get to know these companies as well as we can. And there's really two distinctions, right? There's a value and then there's a price.

Starting point is 00:30:46 So the value, we try to understand the value as much as we can. So if for some arbitrary reason the price goes down yet the value has not changed, You know, we see that from time to time for different reasons. You know, an institution has to sell or some investor has to sell, maybe even an insider has to exercise options or sell for whatever personal reasons. When we see that, sometimes there's a negative sort of sentiment towards the company. And we try to balance or understand, does it make sense? And if it doesn't, then that's a case where we might look at it a little bit differently and say,

Starting point is 00:31:19 okay, yeah, the share price is down. It does make sense to buy it here. the value hasn't changed. In some cases, the value is improved, and yet we're seeing downturned because of circumstances that not reflect in the business. That's when we'll look at something like that. But if it's just down on price, and we can't substantiate, you know, the value. If the value has gone down as well along with the price, then quite frankly, we actually started looking at selling rather than looking at adding your position. We can go and buy something else, right? That's always the driver. We're going to go and find something that just gives us more confidence and

Starting point is 00:31:52 gives us what we're looking for. So as Charlie Munger once said, quote, I've always believed that nothing was worth an infinite price. So now I'm looking more here at what you're going to do with something that you've already held that's gone up in price a lot. So my question for you is, at what point are you thinking it's time to sell a position based purely on evaluation decisions?

Starting point is 00:32:10 So, I mean, we talked about the pay ratio before, right? So that's usually if, when we look at a company in isolation, it becomes, there's two reasons to sell. One is the valuation actually has exceeded sort of that peg ratio, you know, that one, then it becomes, almost becomes an automatic cell. Or if the business itself is broken down. So let's say all of a sudden it stops growing or there's a material event that we think is destroying value or impeding value. That automatically makes us a seller. But quite honestly, but the biggest reason we tend to sell something is because there's something else that's much more compelling.

Starting point is 00:32:50 So yes, this stock maybe is trading at 0.9 of peg ratio. It's not perfectly valued. It's gone up and we're happy and all that sort of stuff. But now we're finding another one that's trading at 0.2 times pig ratio. And it's less discovered than a whole host of things that we look for. Then it becomes a situation where you can say, okay, we're going to start allocating capital from here and start moving it over here. So that tends to be the biggest driver of ourselves. Again, it's handy to be able to look at everything because everything, everything.

Starting point is 00:33:20 In investing is really a function of opportunity cost, and that's a big function of it right there. I'm also interested. So obviously, a lot of these companies that you might get, let's say using this example, you just use when it gets to a 0.9 peg ratio, it might still be doing really, really well, and the fundamentals might be going at a good place. Because of that, are you usually fully exiting positions, like, you know, once it hits something and you have another use for the money, are you just fully exiting? Or do you usually like to leave a little bit in there?

Starting point is 00:33:49 It's pretty rare that we fully exit. Again, if something goes wrong, right? Yeah, we're looking at fully exit as fast as we can. But if they're still sort of executing, they're still creating value, all the right things are still there and it's just a function of valuation, then we're less sort of urgent. It's less urgent to sell, right? We're a little bit more patient.

Starting point is 00:34:10 The thing you have to factor in, too, is the whole idea of taxes, right? Because if you're going to turn over, then you get tax consequences and that actually mitigates your gain. So holding a good long-term winner that gives you confidence and you have conviction in, it pays to hold on a longer time there, even if it's fairly valued. So those are all considerations that we have to use, but we rarely sell our whole position when something goes wrong, partly because if it's grown to a sizable amount, it may be very difficult to sell that and redeploy all that capital all at once anyway. So you're better off sort of slowly selling off.

Starting point is 00:34:49 Look, I mean, it's like the children or your wife or something like that. You don't never want to give up on them. They've done the right thing. You don't necessarily want to give up on them. That conviction is important. You've come to understand that business. Therefore, the new opportunity has to be very, very compelling to be willing to give up all that sort of comfort in that need.

Starting point is 00:35:12 So I'm interested in knowing more about your strategy when a business decreases in growth. So we talked about when it's still going good, but now let's look at when something decreased in growth. So let's go through a quick hypothetical. A business meets your stringent criteria for entry into your portfolio. It had a few good quarters of profitability growing well above 25% in revenue and per share earnings. And you averaged it up to, let's say, a high single digit percent of your portfolio by cost basis.

Starting point is 00:35:37 But now growth is slowed. What needs to happen to get the alarm bells kind of ring in that are telling you, to sell or to wait longer? Yeah, so it depends on how much it's changed, right? If it's gone from, you know, 60% growth to 30%, we may not sell it at all. It might still justify owning it. If it's gone from, say, 50% down to 5%, then it's a function of selling it when you can. Now, some of the issues around, you know, microcaps is that liquidity becomes a consideration.

Starting point is 00:36:07 So if it's not very liquid, you're limited in terms of how fast you can sell at a reasonable price anyway. But let's assume you've got liquidity and you can sell. Again, the driver is going to be what are you going to do with that cash? Is there still a margin of safety in owning it right now? Probably or probably not. And that's going to be the other thing that's going to decide. If the stock still looks real cheap, even though the growth rate has come down as much,

Starting point is 00:36:30 then I'm not as anxious to sell unless I've got that other opportunity. So so much goes back to what can I do with the resulting cash. and that'll determine how fast I'm going to sell isn't. Let's take a quick break and hear from today's sponsors. No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer.

Starting point is 00:36:56 Vanta automates your compliance process and brings compliance, risk, and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Riter spend 82% less time on audits with Vanta. That's not just faster compliance, it's more time for growth.

Starting point is 00:37:30 If I were running a startup or scaling a team today, this is exactly the type of platform I'd want in place. Get started at Vanta.com slash billionaires. That's Vanta.com slash billionaires. Ever wanted to explore the world of online trading but haven't dared try? The futures market is more active now than ever before, and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments, the S&B 500, NASDAQ, Bitcoin, gas, and much more.

Starting point is 00:38:03 Explore equity indices, energy, metals, 4x, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity, you'll be able to trade it in just two clicks once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charts, and you can't even if you're

Starting point is 00:38:33 charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional investors, private credit. Now, the same passive income strategy is available to investors of all sizes, thanks to the Fundrise income fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings yields falling,

Starting point is 00:39:22 it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit fundrise.com slash WSB to invest. in the Fundrise Income Fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses. This and other information can be found in the income fund fund fund's prospectus at fundrise.com slash income. This is a paid advertising. All right, back to the show.

Starting point is 00:40:05 So you mentioned recently that some of your legacy positions were causing a bit of a drag on returns in 2023, even though you had a few very high performing stocks in your portfolio. So I know exactly the pain of carrying legacy positions and what that can do for your overall results. So I'm interested in knowing what are some of the key insights from your experience in investing that help you best deal with legacy positions? Usually, if you decide to sell, you sell. I think everybody has that one stock or maybe a handful of stocks where you sit there and go, yeah, but it still has that chance, right? What if I just wait a little bit longer? Experience should have taught me better that once you've sort of started the process,

Starting point is 00:40:47 it's almost impossible to stop. And the best thing to do is to sell and use not just that physical currency, but the mental currency. This business is so much about psychology and sort of mental applications that why have something that's not working for you and is an eyesore and makes you cry every time you think of it. Why have it in your portfolio? Get rid of as fast as you can move on to something else. There's an old adage that an old broker I used to work with used to give me.

Starting point is 00:41:16 It's easier to give birth than it is to raise the dead. So if you've got a stock that is dead, get rid of it. Go find something else. go give birth to some other opportunity. That's my motto now. But still, I've got to put it a lot more in practice than I have. Yeah, in 2023, I really focused on that. And, you know, I had a few.

Starting point is 00:41:35 Everyone has holdings that they just look at. And every time you look at it, it just feels like the news is bad. You know, they're just not doing what they're supposed to be doing or what you thought they were doing. And it's just like, it's like a mental drain and a strain just to own it. And then so basically I had a few positions like that. And I literally just got rid of them. And granted, you know, unfortunately, I got rid of, I think,

Starting point is 00:41:54 all three of them at a loss, but it makes investing a lot more enjoyable, a lot more fun. And, you know, like you said, right? I mean, there's always an opportunity out there. And a lot of times if your businesses aren't performing well, you're better off just go and find a business that is performing well. What should always ask yourself is when you're holding that stock, ask yourself if you truly believe this is the best investment opportunity that you have access to. And if the answer is no, well, the answer should, you know, the result should be, I'm going to sell it and go find that better opportunity. That's what we do day in, day out is just constantly assume that there's

Starting point is 00:42:29 something better out there and, you know, we look for it. So I know you talk to many public businesses just on your day-to-day life and for small-cap discoveries. And industry experts also, you talk to a lot and have tons of really good friends in the investing community. So I'm interested in knowing how you've built up such a good network and how that network has improved your investing. Yeah, a great question. I think, you know, like I've been at this now for about. 30 plus years. So a lot of it's just, you know, accumulating experiences both good and bad. I think it's really vital, especially when you're investing in the microcap space, is to get to know the players, right? I understand the system too, right? We talked about

Starting point is 00:43:09 financing in the past and how important is to understand how that works and who the players are and, you know, what can go wrong, what can't go wrong. You know, accumulating a network investors is really important because, you know, you can't expect to know everything. You can't expect to know everyone, right? So a lot of times I'll phone up somebody who may know, you know, the management team over here or in this other business. And all these little clues are things that are going to help build your conviction, build your understanding of the business.

Starting point is 00:43:40 So it's important you reach out. It's important you ask questions. And I think the other thing is I find a lot of people, especially in the microcap space, well, quite frankly, even in, you know, investing in general, there's a lot of people that are willing to give back and help people who are starting out and answer questions and, you know, in some cases, mentor, you know, young people who are trying to build their network. Those things are really, really important. And you can fast track your learning by getting in front of as many people as you can and ask them, right? Yeah, sure, some are going to say no, but get out there

Starting point is 00:44:12 and talk to people. Ask them. Ask them what their experiences were. Ask them for help. You'd be shock. Know what people's motivation is as well, right? This is an industry that, you know, typically people get paid for either information, they get paid for doing things. You know, understand that, help when you can, understand that, you know, some are looking for payment for things, and just get out there, get out to conferences, ask questions, phone companies. You know, microcaps are the type of companies where if you pick up the phone and try to talk to CEO, you're likely going to be able to talk to them. You're not going to be able to pick up the phone and talk to the CEO of Google or I think your answer be pretty low.

Starting point is 00:44:51 So get out there and start that. And then after a while, you'll find that your network starts to actually work for you. Ideas will be shared, different bits of information, come back and forth. And then that's what this business is all about. Yeah, one thing I've really noticed just honestly from doing the same kind of things you say, which is, you know, asking other people for help and, you know, reaching out to people, asking questions and contributing to other people is that once you start getting a network of people who really know you and like you and who you've helped before, people just share ideas with you.

Starting point is 00:45:23 And it's awesome because these are people who know you, right? It's not like, if I came up to you and were like, oh, hey, Paul, I got this really good idea. It's called Apple. It's like, okay, well, I know you well enough that you have zero interest in that idea. So you'll get people who know you and know your investing style and know the types of investments that you look at. And it's powerful and it can really help with efficiency too, right? I mean, like, if obviously, I know you do all the work your own and you know, you're probably not relying on other people for too many ideas, but it helps when you have other people who can kind of steer you in the right directions with just saving time.

Starting point is 00:45:57 Immense amount of time is saved by having the right people. And look, I mean, there's, it's impossible to know everything. So, you know, real world examples, there's companies that we've looked at, the life science space, so pharmaceutical space. and we know people in the industry now through, you know, our relationships in the past. And when we have a tough, you know, sort of question or something we need to understand, we'll reach out and sure not, they know what we're all about and they'll gladly help when they can't. That's the beauty of this sort of stuff is that nobody on this planet knows all the information

Starting point is 00:46:27 and you reach out and you have people there who are willing now. So small cops have historically outperformed all other deciles of the market. And with how much of a run the magnificent seven, had in 2023. It seems that perhaps capital may once again flow to small caps, but who knows? It does seem like it's taken a long time for microcaps to have their day in the sun. I'm interested in knowing what are you seeing in the market today that makes you bullish on small caps for the future? The market is made up of all different stocks, right? So I'm a believer that value always does well. When it's a value, mispricing. So if something is growing

Starting point is 00:47:02 and it's not properly priced, that over time that will perform and do well. I've seen sort Over the last two years, I'd almost call it two different markets. You can even say three different markets. The big stocks for sure and the indexes and the stocks that everybody knows, they've done exceedingly well. Then you get the rest of the market, right? And I'll call it the smaller companies. Within that component, I'd break it into two different pieces. One is the profitable and growing smaller companies and then everybody else. If you look at the small companies as a group, yes, that's performed quite poorly over the last two years. especially in comparison to the big guys.

Starting point is 00:47:41 But if you look at the small and growing profitable companies, they've actually done really, really well, like really well. Three different kind of markets to look at. If you look at the whole thing, you go, okay, well, Mark kind of looks okay. It doesn't look too bad. If you're just playing in these sort of money losing small companies, you're going, oh my God, it's been terrible for the last two, three years, right? But then if you're that other sandbox that I love to play in,

Starting point is 00:48:05 You know, we've had a fantastic year last year. As a matter of fact, we've had two fantastic years when everybody else has been complaining about the small company. Now, going forward, what I think is interesting is that more and more people are starting to figure it out. We're starting to see a little bit more bigger capital come down market, and they're starting to distinguish between those two sort of smaller markets. The small companies that we look at that are profitable growing, they're not as cheap

Starting point is 00:48:30 as they used to be, right? So we're not finding as many, you know, no-brainer opportunities as we did two. years ago. So that means capital is coming in, but it's nowhere near the kind of capital we've seen in prior sort of bull markets for small companies. So I think there's a tremendous upside for these small and growing micro-cap companies because that institutional capital is just starting to trickle down market right now. And when it does, you get a really euphoric bull market. Now, the other market, that money-losing market, now, you know, I know the industry, institutional players and investment bankers need to eat.

Starting point is 00:49:05 And they have to go and generate revenue for themselves. And the way they do that is through financings. So I do think you're going to start to see, you know, the last two years there's been absolutely almost zero IPOs and financings. But you're going to start to see that research, in my opinion. I think you're going to start to see the whole smaller market is actually going to do significantly better than it's done the last two years. I think the profitable growing companies are going to continue to very well because of that

Starting point is 00:49:30 capital coming down market, but I think some of that capital is going to go into that sort of the more speculative area as well. And I think that's going to boy the whole market. If I were a hedge trader and I could hedge the big markets, I'd be selling the big markets and going along the small markets because I think there's a huge historical mispricing of those two assets right now. Historically, small stocks always traded a premium to big stocks, and now we're seeing the opposite. So yeah, one thing you mentioned there that the last two years for you guys have been really, really good, even though, you know, the market, broadly speaking, for small caps hasn't been good. So I looked at like the performance of some of your cheapies

Starting point is 00:50:08 with a chance over the years. And it's pretty incredible how it just always seems to do really, really well. So it seems almost like it doesn't really even matter if, you know, you're not getting a huge influx of money into these small caps. It just seems like because the businesses that you're looking at are really, really cheap, you know, you just need a couple of eyes on it. and that can generate returns even in the presence of a market that isn't necessarily conducive to success. Okay, so a couple of things to unwind, right? Institutional investors, typically in Canada, they look at companies, you know, at the earliest stage, usually about $50 million market cap.

Starting point is 00:50:43 You really have to get to about $100 million market cap before the real institution money starts to play. So what you want is you want to find a company that maybe it's a $40 million or maybe $50 million market cap or whatever. But if it's growing and it continues to grow, Sooner or later, it's going to get to that size and it's going to show up on the radar screen to these institutional players. So that's the beauty is if you can find those companies that are doing the right thing, sooner or later, it's just a function of time. Now, sometimes what happens is it's not a function of time. It's a function of the sentiment in the market, and it improves. And all of a sudden, these guys, instead of using $50 million as their cutoff point, they start coming down to $20 million.

Starting point is 00:51:21 They come to the market and they generate it. So it's just a function of time. It can happen over a couple of years or can happen very quickly if the sentiment starts to change. And like I said, we're starting to see the sentiment change right now. So we actually think we're going to get that lift that has not really shown up over the last two, three years other than just these companies were growing. And so during times like this where ideas are just a lot harder to come by, I mean, I follow obviously a lot of the businesses that you follow. And, you know, the prices have gone up quite a lot and a lot of them. and they don't look quite as attractive as they once did.

Starting point is 00:51:56 Are you usually just kind of just staying in the positions that you have and letting them run and maybe you'll give them a little bit longer of a leash because there's less opportunities, like you said with opportunity costs because there's maybe less opportunities out there. You're just more likely to let them run and see what they're going to do for the next few quarters. Thankfully, I've been around this business for a long time. And what I recognize is as much as they've gone up, they haven't gone up to what they typically trade us. We look at these businesses and yes, they've done well. in some cases, they've doubled or tripled in the span of the last year, but they're still not

Starting point is 00:52:26 close to where their valuation should be in a normal market. The other thing I learned very really in my career is that especially in Canada, the institutional capital that's out there really drives the markets. It's not the retail market, it's the institutional capital. And there's a massive amount of institutional capital out there. Now, when they really come to play, it has a dramatic effect on share price. So the stock that might have been trading at 10 times earnings that it doubles in price because it's grown and multiple is expanded to 20 times. You're sitting there going, my God, I've tripled my money. But then along comes an institution and sits there and says, oh boy, if this keeps doing this

Starting point is 00:53:05 for five years, this thing is a tin bagger from here. So now they actually go in and they price it even higher. So we have not really seen that take effect yet. These stocks that, even though we're not finding as many great opportunities, they're still good opportunities. When that institutional capital comes down, you're going to see a. another, we call it another discovery point in the discovery cycle. And that institutional discovery cycle is the most impactful and the fastest driver of change in share price that you can

Starting point is 00:53:34 imagine. So yes, we sort of complain that we're not seeing as many good opportunities, but the opportunities we have, we're still highly convicted that that institutional capital when it comes down, it's going to have a material impact on share price. That institutional discovery process that you just discussed, is there like a general duration that lasts for or is it just basically completely dependent on market forces and there's too many variables to think about? There's a number of things that impact it, right? So we've had a rough market in Canada and rough market for small caps in Canada in general.

Starting point is 00:54:08 So there's not been a lot of capital going into these institutional small cap investors. So they're kind of playing with a certain amount of cash. Now, there are issues around what they can and can't do in this environment. If a small company is not liquid enough for these institutions to buy them, they can't buy them. Now, you get a bull market, you get two things happening. There's more capital that goes into their portfolios, and more of these companies become liquid. So you get those two effects starting to impact, and all of a sudden, they're playing ball. So that is yet to happen.

Starting point is 00:54:41 That's what I'm talking about. When those two things happen, you have this bloated. amount of cash that has to squeeze into a small supply of companies because that's all there is. They're just not enough. I remember there was a time when we did a little bit of a study and there were more small cap funds in Canada than there were companies that they were qualified to buy. So you have this weird dynamic that as soon as a company hit a certain inflection point and was doing the right things, you had like 20 these funds would jump in all at once and of course

Starting point is 00:55:10 that would drive the share prayers like crazy. I think we're about to see that again. Paul, thank you so much for coming on to the show today. Where can the audience learn more about you and small cap discoveries? Well, first up, Kyle, thank you. It's always fun to talk to you. I love this stuff. You can see I can talk for hours and hours.

Starting point is 00:55:27 But anybody interested, they can find, well, they can find our service at smallcap discoveries.com. If anybody's interested, you know, we'll give them a free trial if they're, if they mention you and your service. Also, you can find me on Twitter. I'm crazy Twitter poster. I'm there at Paul Andriola. And yeah, and, you know, if they reach out and they've got any questions regarding anything around this sort of stuff that we talked about, I'm happy to answer and help how I can.

Starting point is 00:55:55 Okay, folks, that's it for today's episode. I hope you enjoyed the show and I'll see you back here very soon. Thank you for listening to TIP. To access our show notes and courses, go to the investorspodcast.com. Follow us on TikTok at the investors podcast on Instagram and LinkedIn. at the Investors Podcast Network, and X at TIP underscore Network. This show is for entertainment purposes only, before making any decisions consult a professional. This show is copyrighted by the Investors Podcast Network.

Starting point is 00:56:28 Written permissions must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP607: Small But Mighty: Uncovering Smallcap Value w/ Paul Andreola

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.