All cap investing with Kirk Spano

0:09Kirk Spano:Very happy to welcome back Kirk Spano, two investing experts. For those who have forgotten or never knew that your investing group on Seeking Alpha is called Margin of Safety Investing, I wanted to start, we had another analyst on a couple episodes ago, Courage and Conviction Investing. I'm not sure if you're familiar with his work. He focuses mostly on small and mid-cap companies. We've had him on a few times, like we've had you on a few times. You're both thoughtful analysts. And his take, not to get too far out of the weeds already to start, but his take was one of, you know, he's focused on small and mid-cap companies.

0:52Kirk Spano:So he's a bit depressed in terms of his returns so far this year. And he updated us on where those stocks are and how he thinks about those stocks. And we had a few commenters talking about, you know, it's kind of a bummer to listen to somebody be bummed out about where their stocks are going, where their portfolio is. Whereas I feel like it's super refreshing to hear somebody give kind of a somewhat downhearted have taken a somewhat downhearted moment for their stocks and looking at the markets, it's a bit hard to suss things out. I'm appreciative of people taking a real take, especially when it's hard to know exactly what to do.

1:34Kirk Spano:So all of this is to say, you're a thoughtful analyst, you're a thoughtful investor, you're a smart guy. How are you looking at this present moment with the depressing news, with the depressing things coming out of things, coupled with the somewhat bullish announcements, which there are to be had. Where's your mind at as we approach October 2025? Wow. Yeah, yeah. So I am an all cap investor. So I will just go where the money is. And that has helped me for a very, very long time. I have been known as a small and mid-cap investor, but my biggest wins were buying Facebook when they crashed after their IPO back in 2013, I think it was, maybe in 12, right around there.

2:31About the same time, I wrote some articles about buying Apple when everybody hated Apple. And I bought Google early. I was in Tesla way back in 2014 to 16. So I got in that early. So a lot of my big winners actually were big caps, large caps that became mega caps. So I'm not completely depressed by the small cap performance. But there is a systematic element to that that I think people probably overlook when they take a look at the cycles. And that is that about 70 % of the companies in the Russell 2000 are not profitable, and they probably will never be profitable for the most part. That index is a crummy place to invest.

3:25However, it is a great place to pick out stocks. So if you can find catalyst-driven companies in the Russell 2000 and scale into them, and we have a way that we do it that makes us money, then you can, on the basis of your stock picking, do very well. We have notably invested in companies like AST Space Mobile and Rocket Lab in the last couple of years. We bought Palantir under 10. I stupidly sold it in the 40s. And I'm living to regret that decision to sell. So ride your winners is a real thing. We're still in AST Space Mobile and Rocket Lab that we bought under five. But we have several others that have just been chopping along for a couple of years.

4:21Well, the stocks that chop along, the ones that the catalysts get delayed or missed, we sell a lot of covered calls as well as cash secured puts. And what we have is an option wheel strategy that several other people practice on Seeking Alpha. we use a lot of technical analysis so we have an option wheel strategy that uses technical analysis that allows us to sell cash secured puts a little closer to dips or in dips and sell covered calls on some of the rallies and it's an imperfect strategy it's never going to be you know perfect But as Vince Lombardi said, if you just keep trying to make good decisions and you work hard and you strive for perfection, you can reach excellence.

5:21So I recently published my performance for the year. We're up 36%, 37%. And it's mainly on the back of some good stock picking. AST, Space Mobile, and Rocket Lab have been a big part of that. very Peter Lynch have a few big winners and it carries the day. But systematically, we have sold a lot of options, a lot of cover calls, a lot of cash secured puts, and just grinding out all that income, especially in tax deferred accounts that works well. We've been able to do well. So as a guy very empathetic to being a small and mid-cap stock picker. I get it that a lot of people have had a rough time, but I think that it's largely because they didn't have a way to deal with an index that didn't do well.

6:18So I would never buy IWM. And they didn't have a way to grind things out. If you're a baseball player, you can be a home run hitter or you can be a singles hitter, or you can be very well-rounded and do all the things. We try to do all the things. We're not great at everything or things don't always work out perfect. We've had clearly some of our dogs. One of my favorite stocks out there is a little refinery company called Ametis, A-M-T-X. It reminds me of a company called Tesoro, which is now a little company called Marathon Petroleum that I invested in like 15 years ago. And the catalysts to drive that stock up have gotten delayed by the California government and by the U.S.

7:13government under Gavin Newsom and Joe Biden. You know, they promised a bunch of things that did not happen. And I'm a pretty, you know, sympathetic to that side of the aisle guy. But here under President Trump started to happen. Those catalysts have started to manifest. And maybe this is the year next year is the year that a metis goes up. When you small cap invest, you're going to get a lot of delayed things. And that can depress the stock price, especially stocks that don't have a ton of institutional investment. You know, when institutional investment is below half or around half retail investors can whip it around you're subject to the trading rooms and the discord rooms and the hedge funds putting pressure on small cap stocks because they can overwhelm the share price which is something i'm writing an article about so people understand how small cap stocks get ganged up on by groups of traders that are loosely affiliated through social media and trading rooms And I think that if people understand that, they can devise a strategy to get through these two and three year downturns or choppy periods without getting depressed.

8:35So I think there's always a strategy or a tactic to deal with what's going on out there. And the question becomes is, do you have the tools in your toolbox to use those tactics and strategies? And always remember that with the SMID cap investing, you are really looking for stock picking. The indexes won't necessarily do it for you in a day and age when over half of the money gets just put into the S &P 500 index. In a world where you have efficient markets and inefficient markets, it's the inefficient markets, the ones where there's not a systematic push up on prices like there is with the S &P 500.

9:30The inefficient markets, the small caps, mid caps, the emerging markets are probably the places where you have to be more selective, either pick industries or individual stocks. So that's kind of the worldview on small and mid caps. I think that if people pick well, and they're patient, things, you know, generally work out. And I think that the thing that people really have to avoid is running out of patience. you know people sell this time of year and say i'm taking the tax loss and then the stock goes straight up that is not something that works out well for people i i i have a stock out there right now that uh dropped maybe 30 or 40 percent from its peak and somebody who bought it at the peak sold it a month later and now it's back up and they're like well now what do i do well you got your you got your little tax write-off however you missed out on a 30 or 40 rebound rally if you're not a great trader don't trade right and i know that everybody wants to take a tax write-off because oh i can write it off against something else but the reality is is that if you're truly making good stock picks you just want to hold them for the most part i mean there are occasions to harvest some tax losses but generally it's not the end of the year it's usually the middle of the year and that has to do with seasonality and the way the institutions invest and the way they push prices around so i just caution anybody who is depressed about their small and mid-cap performance from just selling at this point.

11:22Because at this point in the year, you don't know when the next rally starts. Seasonally, it'll be November. So is it really the right time to sell? I doubt it if you selected well. I wouldn't trade out on the volatility at this time, usually. I mean, company-specific, you might want to. But in general, people losing patience and taking tax losses at the inopportune time is usually a bad idea. Most corporations and institutions, they take their tax losses months earlier than the retail public. So they're buying at the end of the year when retail people are selling. you you don't want you don't want to be selling to the big guys when you're close to a bottom price right that is the classic trap is retail sells closer to the bottom and institutional or corporate investors or family offices invest you know when retail is selling so don't be their sucker I guess would be the way that I would put it at this point because I know a lot of people are tempted to sell right now.

12:44And if you haven't already sold your losers, you may not want to. What you might want to sell right now are a few of your winners if you don't think that they have a lot of upside left, especially going into the shutdown, which as of this recording, we're just a few hours away from. So if we get volatility on an extended shutdown, and a shutdown of a few days won't matter. But if this becomes an extended shutdown of the government, we can take a look back at 2019 and 2018, excuse me, and see that the threat of the shutdown ended up correlating largely with a sell-off in the stock market. Will history repeat or rhyme?

13:29I don't know, but it might. so i've been encouraging people to manage the risk on the large caps that have run so far up and are at historically high valuations not so much the small and the mid caps i think that those are some of the again if you're a good stock picker great place to to to accumulate and to sell cash secured puts and generate some income and some of the large caps not all of them but a lot of them, they're at the highest price to earnings ratio and peg ratios, not only in the last five years, but really in the last 25 years. And that is, to me, a bit of a warning.

14:16Kirk Spano:Definitely some concerning times when you're looking at some of these valuations and other metrics that you've pointed to and some of these large cap stock questions that remain. Curious if you would give us maybe another one to two minutes on when and why you use options and covered calls and when you utilize those tools. I'm a believer in a relatively concentrated stock portfolio that sits alongside of a more diversified ETF asset allocation, and it's worked for me. Now, that doesn't mean that it will work for everybody, but it's worked for me so I keep doing it. I'm of the Mark Cuban school, figure out something that works and just keep doing it until it breaks.

15:05So a handful of ETFs as my asset allocation backbone or core with about 20 stocks is where I gravitate to. In the stock portfolio and even some of the ETFs, there are pretty robust option markets. And because the number of traders has roughly doubled since pre-COVID, and because the use of margin and the use of options has gone through the roof, you can sell options at very high premiums. Now, I've been doing this 30 years as of this year. This is my 30th year. And my mentor was an option seller, mainly covered calls. And after the financial crisis and the start of the first rounds of quantitative easing, it started to become apparent that the cash-secured put selling would become a pretty good strategy.

16:02Prior to that, almost everybody just sold covered calls. Famously, some guy in Omaha named Buffett, I think his name is, has sold cash-secured puts against the S &P 500 a number of times in his career Because he has a huge pile of cash from the operating businesses at Berkshire Hathaway, he wanted to increase the return on that cash. So he would sell a cash-secured put on the S &P 500 with the reasoning that regardless of what it does in the short term, in the long term, it goes up. So he could generate a bigger return on that cash by selling a cash-secured put. But over the years, especially since 2016, when QE3 or 4 or Twist or Infinity or whatever it was called happened, cash secured put selling on the dips has been an incredibly good strategy.

17:00So if you take a look at a chart of the SP500, what you'll see is that buying the dips has been a great strategy. And really any stock that over five or 10 years is chopping its way higher, selling cash secured puts on the dips, just like buying the dips, has been a very good strategy. The reason we sell cash secured puts over and over again when the market is choppy or when it's down is because the volatility in the market and the inherent gambling nature of all of these retail traders that are new to the markets drives the premiums up. and you get a very big internal rate of return, a very big annualized rate of return on selling cash secured puts on stocks that you would love to have assigned to you and own at these slightly lower prices.

18:05And the thing is, is that probably three quarters of those puts expire if you're even a decent stock picker because stocks gravitate higher about three quarters of the time. So when you take a look at the amplification of those premiums due to the gambling nature of the markets today, your time value deterioration ends up giving you internal rates of return of annual rates of 30, 40, 50, 60, 70, 80 % on your cash that is securing those puts over and over and over again. So mechanically, when you sell a cash-secured put, if you think of it like setting a limit order to buy, but you're getting paid for it, that's the way that we think of it.

19:01So AST Space Mobile, a stock that I told everybody on Seeking Alpha to buy when it was$5 a share. The article is out there. It went up into the 50s, just barely, and we sold covered calls. at 60, 70, 80 bucks, and we're getting two, three, four, five bucks a share. Well, that was basically our cost basis. Those covered calls expired because the stock chopped along and went sideways and went and even corrected into the 30s. Well, when the stock was heading down to 45 and 40, and for a minute was in the 30s a month or so ago, we sold 40 and 45 and even$35 cash secured puts because we would have loved to buy more of the stock at those prices but we were getting premiums and you can go ahead and check this through fidelity or schwab or whoever you use we were getting premiums of four or five even six bucks a share it's a fantastic strategy and now the stock is back up to 46 47 whatever it is today probably all those cash secured puts are going to expire in the next month or two we can buy some of them back if we want to at a profit so that's where some management comes in you have to decide do you really want it assigned to you or not if it's stock prices fall but that is a strategy that with a little bit of technical analysis and we don't use a lot of technical analysis.

20:40We kind of cheat. We use some very vanilla indicators. We use the relative strength index, RSI, but we don't measure it daily. We're not short-term traders. We measure it weekly. So when you measure something in the stock market, you pick a timeframe by the minute, by 15 minutes by an hour by four hours by a day by a week by a month the weekly time frame within a within a cycle within a full market cycle tends to give the best signal for people who would consider themselves more position traders than swing traders so we're more position traders that means that we actually like to hold our investments for quarters and years you know We don't do a lot of things that are based on days or a month or a quarter.

21:36We would like to own our holdings a pretty long time, especially longer than a year so that we can get the capital gains tax break. So that weekly timeframe on RSI, when it approaches oversold, right, 40, 30, right down in there, you can generally sell cash secured puts on a stock. Again, caveat that you picked a good stock and generate a big premium. Probably it's not assigned to you because it's already oversold and time will drive it back up. but if it is assigned to you you're getting a pretty good price so you're buying low so you win win either you buy low or you just keep all that premium with an annualized return of some big double digit number in most cases every now and then you hit a home run and it's higher every now and then something you have to close and you don't make any money but on average you know you're making for us it's been around 30 percent so you know you take a look at that and you're like it's a pretty good strategy if your foundation of stock picking is pretty good to begin with so you just use like the karate kid right the new karate kid movie just came out use your your opponent's leverage against them just like the karate kid did right that's how he won his fights there's so much gambling in the stock market today selling a cash secured put is like being the casino right you're you're the one getting the vig i love getting the vig pay me pay me over and over and over again and if you do that systematically and again on a foundation of good stock selection to begin with uh you can beat the market has been our experience and you can do it with roughly the risk of a balanced portfolio because we typically have 40 50 60 percent of our portfolio in cash with the other 40 50 60 percent in stocks But that cash portion, you know, only gets assigned into the stock market, into the stocks that we have sold cash secure puts on, if prices drop 10, 20%.

24:06Well, that's a pretty good margin of safety, 10, 20%. Plus, we have the income that we've collected. so you know we're roughly taking 60 to 80 percent of the risk of the S &P 500 but we're beating its return to me that's a pretty good risk adjusted return and I've been doing it pretty successfully now since about 2016 since I've been on Seeking Alpha and more QE I think there is a question to be begged, which is, are we going to get QE again? Are they going to keep the markets highly liquid? I think that's a big conversation. I think the answer is probably, but with long and variable legs.

24:53Kirk Spano:I'm tempted to get into the QE conversation, but let's stick for a second on the stock side of things. I'm curious your thoughts about, you know, there's so much talk about AI and speaking of the S &P 500 and what's actually in that and how, speaking of diversified, how diversified it isn't. What would you say about large cap names and the tech sector? You were also one of the first people to come on Investing Experts and talk about how you see the AI play more in healthcare. You were talking about Pfizer than you do necessarily in the quote unquote tech sector. Talk to us about how you see tech stocks, or I should say large cap names, and how you see that developing over, let's say the next year?

25:44When you manage a hedge fund, which I do not, but when you manage a hedge fund, you have what are called channel checks. And I have developed since I've been in the press back in 2011, I've been able to develop some pretty good channel checks. And I have a number of clients in Silicon Valley who have helped me recognize some things a little earlier than other people. So not only was I pretty early in Facebook, Apple and Google, and you know, I actually my first stock, one of the first stocks I ever bought was Microsoft, way back in the late 1980s, for a high school project, they have helped me understand it.

26:30I just got off the phone, actually, with somebody who works at Supermicro, because I, I helped them with their money. I think that AI is the most important thing since the internet. And I think the internet provides us some good analogies for what's going on. First off, when the internet was built out and we had the dot-com boom, there were all kinds of companies that weren't profitable and were never going to make a profit. But they built out all this internet infrastructure. and ultimately the internet became very cheap and the companies that made money on the internet either had software as a service or something to sell so while you had qqq you know at the time i think there was an extra q drop whatever it was 80 off of its peak that was kind of the first iteration of this super long-term technology super cycle that we've been in big secular trend And the culmination to this point, who knows what we'll invent in 20 or 30 years, but the culmination of all of this at this point is AI.

27:45I think AI is bigger than the internet because the applications for business and for changing standard of living are bigger. It is understated how much our quality of life can be improved with AI. if, and there's a lot of ifs, if it doesn't eat us, right? If it doesn't kill us somehow, and if it doesn't make our brains turn to mush. One of the things that I've seen with AI is people will go and use whatever their favorite AI is. I use perplexity. And they just type in a half-assed question, and they get an answer, and they just think it's gospel. Well, first of all, AI doesn't reason. Not at this point.

28:34It really is just an aggregation of what it finds on the internet. So the looser your question, the looser the answer and the less valuable it is. So when you use AI, you have to ask good questions. You have to build the conversation to get the information you want. And then you have to source check. And almost nobody clicks on those source links, but you should because you'll find a lot of garbage and a lot of old stuff. So when you work with AI, there is a better and worse way to use it. I don't know which way we're going to go on aggregate. I'm afraid that on aggregate we use it worse, but we'll see.

29:15For me, it beats the hell out of scanning PDFs and doing spreadsheets myself. I have become at least, at least 500 % more efficient since I started using AI five years ago. The first AI I bought for the financial industry with a really hard to use dashboard was$20 ,000 a year. Centio, AlphaSense and them have merged since. Today, I pay$200 a year and I might end up paying two grand for an even better version, but I pay$200 a year for the Perplexity Pro which is what 99.9 % cheaper, 99 % cheaper. And it's at least 10 times better. I don't have to learn a dashboard. I just have to build my queries in a way that I actually get the data and the information that I need to make decisions and analysis.

30:18I think that the day is coming where we are much more efficient. Not to the point where we lose jobs because I think that most jobs in a service-based economy, which we are, 70 % of jobs are service-based, instead of working 60-hour weeks or 50-hour weeks to get ahead, the 40-hour workweek for the workaholic will become a thing. And for everybody else, it'll be a 30-hour workweek. A lot of four-day workweeks, maybe three and a half, whatever. I don't think we're going to lose jobs. I think we're just going to work a few hours to get it done. I think for corporations, that leads to a pretty big improvement in margins if they can maintain their prices.

31:02The thing is that in free markets, which we don't really have, but we have, you know, kind of a hybrid type of market. We have a lot of oligopolies. There is often a race to the bottom in pricing. And when Warren Buffett would talk about companies with a durable comparative advantage or competitive advantage. What he's really getting at is pricing power. And he talked about that in lots of his letters. As investors, we need to find the companies that can maintain their pricing power while their cost of doing business becomes cheaper because AI helps them become more efficient. Some companies, this will work very well for.

31:46Other companies, it won't matter so much. So you have to, as an investor, find companies that can maintain their margins because they can maintain their pricing. And at the same time, the company internally becomes more efficient, largely on the back of AI. That is what I'm looking for. And I think that there's a lot of winners out there. I think a lot of industrial companies will do well. I think a lot of pharma companies will do well. I think it's the big pharma that will do better than the small biotechs. I think a lot of people out there are in love with the idea of investing in small biotechs because they might have the next big thing.

32:23But in a world of data where large quantitative models are coming, right now you don't get that with Perplexity or Gemini or OpenAI. But the quantitative models, not LLMs, which are large language models, but LQMs, which are large quantitative models. And you can go to a website called Sandbox AQ or Sandbox AI or something to find out about that. The companies with gigantic data sets like Pfizer or pick a big company with the money to pay for computing power probably will be able to do what the upstarts have always done all by themselves. They won't have to pay a premium to a small cap biotech because they want whatever thing it is that they're working on.

33:14They'll just say, that's a good idea. We're going to do it too. And because they're gigantic and they have money and they have compute, they don't have to pay a premium to the small cap biotech. There are giant companies with big advantages that are undervalued. I think Pfizer and Ford are two of them. And there's a bunch more. So the users of AI ultimately are the ones that I think win. And I think that that is good for a small guy like me. I think it's good for a giant company with a big checkbook and a lot of data. And there's probably lots of winners in between. But at the same time, in other spots, it'll just lead to an erosion of pricing power and more competition.

33:59competition and it's hard to make money when there's a lot of competition so where are the oligopolies to invest in where are the companies that will go from being undervalued to being overvalued as they become the narrative darling of retail investors you know they're out there they're hard to find you know large caps are are mostly an efficient market right most of the information is priced in, but every now and then you'll find some large caps where the information is not priced in. To me, the sweet spot is mid caps because they're under covered by Wall Street. They're under invested because indexers don't get in there.

34:41And the mid caps that get sucked into the S &P 500 over time, to me, those are the ones that have the really rare combination of big upside without a lot of risk. And there's not many of those out there, a few dozen a year, but that's probably where I hunt the most. And I think that those mid cap stocks that benefit from AI probably are what most retail investors should be looking at because a company that goes from not on the S &P 500 to on the S &P 500, now it gets a chronic bid, right? Because half the money goes into the S &P 500. So if you get into the S &P 500 right now that you kind of have a new floor on your price, you become much more correlated to the S &P 500 at that point.

35:30So mind your S curves, but those mid caps that are getting pulled into the S &P 500 over the next few years, to me, that's the biggest potential return you can have without taking a lot of outside risk.

35:45Kirk Spano:Do you want to get into QE now? Hey, this is your circus. I'm just the clown. This is my show. All right, dance. Dance that QE dance, Kirk. So QE really had, you know, I'm an economist. QE has really changed everything for a very long time, going back to before the Roman Empire. And the Romans are the ones that always get cited, but other empires did it too. They all printed money. So when a government overspends or just doesn't tax appropriately, which is what I think the case is in the United States, they end up printing money when they get upside down. The United States is$37 plus trillion upside down right now.

36:27And I know that there's a lot of fringe theories out there about repricing gold and we'd be out of debt. Well, that's not true because even if we repriced gold to 80 % of the spot price, you're only looking at another trillion dollars. So we got 37 trillion of debt. If you take a look at the way the tax code is structured, and as I've gotten wealthier and I've gotten more tax breaks, I don't understand it, but I take them. About half of all the tax breaks since 1981 went to 1 % of the people. The other half of the tax breaks were spread out across the other 99%. I forget whose study it was. It might have been the GAO.

37:09I think actually it was the Heritage Foundation, which is pretty conservative. About 80 % of the tax breaks since Reagan have basically correlated directly to the federal debt. So 80 % of that$37 trillion is tax breaks. About 20 % is new inflation-adjusted spending. So when you take a look at how this all works, we got into a situation going into the financial crisis where leverage was high, quality was bad, right? Just as a shortcut to understanding it. It was a perfect storm of like 10 things. But basically leverage was high and quality was bad. Easy way to understand it. Everything collapsed.