Ian Cassel’s Rules for Profitable Small-Cap Investing

27:19Having successful founders who have high net worths, how do you measure if they're as driven as they were the first time? I think, well, I think one of the things that a lot of these successful leaders do is they do build great teams, you know, and they have great people around them. In fact, you can find a lot of hustles in micro cap, you know, the very small ones, and they can take a business from 5 million to 20, you know, but they never put the great people around them to take it to a hundred. And so for me, like I like to find those things at 20 million market cap, they're super small. And a lot of my decision making is around, are they putting the right team together that can cross that chasm from hustle to scale?

28:09And so for me, it just gets back to, are they building a team that can scale, the processes that can scale, the culture that can scale? And a lot of that, you don't really know until you kind of follow them. You get on site. You have reps with the CEO. You get to know them. You spend five hours with them in person to where after an hour or two, the sound bites run out and you find out who they are and how they really are. It's all that hard work, that leg work that goes into it that ultimately and it doesn't mean you're going to be right, even if you think this is the right person. Like, hey, my hit rate's probably 55, 60 percent.

28:45And I think I know what I'm doing. um but it it comes back to that management and just at least giving yourself when you're sitting down the poker table and and you get given a a full house you know and you could still lose with a full house but your chances are pretty good you know that's kind of what you're looking for here at microcaps maybe another dumb question but like what is the incentive to go public at a small size like that? It doesn't seem like it's generating that much capital. Yeah, it's happening less and less. It is dependent on the geography, like I would say here in the US, because there's micro caps all over the planet because they're just small public companies.

29:29So 60 ,000 public equities in the world, roughly 30 ,000 are these small micro cap companies that no one's ever heard of. And you can find them in Japan over here, in every market. here in the U.S., going public small over the last 20 years has gotten less and less. Now, you still have companies going public, but I would say the quality level of the small company going public has gotten worse. There's very few Walmarts in 1970 going public as a microcap, where they did back then. That type of quality, something that's really growing and profitable. Yes, you have companies that are trying to raise 10 million for a phase one trial or more of a story stock bent to it.

30:17Less real businesses. And that's actually something I'm trying to change here in the US. It's like one of the things between MicroCap Club and our in-person events at planetmicrocap.com, you're just trying to pull in quality investors, quality companies, and just getting good companies to go public again. And the benefit to them is the fact that if you do have a business that you believe you can grow 15, 20, 30 % a year organically and increase that revenue every year, increase the profits every year, I don't care if you're selling toothpicks. If you can do that consistently over five years, you're going to get a higher multiple than the private markets.

30:58You don't have to sell your small business to private equity at four times EBITDA. You'll probably get 15 times if you're even a small microcap, if you can consistently grow revenues and earnings and not dilute. If you can generate enough cash that you can fund that growth internally. I presented at a few small business events and no one ever even thinks about going public as a small business here in the US. Now, Canada, not quite as bad because their venture capital areas aren't quite as robust as ours down here yet. So Australia, you still have some going public there. And so over time, it's become important for micro cap investors that take this niche of investing seriously to expand their geographical arena to these other markets where you still have more robust small companies going public in places like Canada or Australia and Asia.

31:53That's becoming more important. And luckily with today's technology and day and age, you can be active in pretty much every market in the world thanks to interactive brokers or whoever you use. So it's kind of opened up the world. Has it ever made you think about maybe switching to doing some private investing rather than just only equities? Well, what it's done for me now is I now, so I was a full-time private investor for 10 years. So call it from 2009 to 2019. And then I launched a fund. So now I don't call myself a full-time private investor anymore because now I'm a fund manager, if you want to call it that.

32:33And kind of what we do in that fund is a combination of both things, but still in the microcap landscape. We can provide capital directly to companies and fund them as well as being an open market buyer of the stock. So we kind of have this hybrid PE VC meets public, you know, micro cap type. And it really works out well because I'm pretty close to management teams. I like to give them good advice. We see ourselves just like a VC does, or at least the good ones as being a value added investor, not just a value investor. And so we have, I have seen that. That's how I've seen that kind of manifest itself in my investing style now.

33:15And now that we have more capital to invest and we're doing more of those placements directly and getting getting good terms on them because those because our reputation sort of precedes us in microcap where the management teams want us on their cap table as well um they know we we aren't looking to sell the stock next week so um and that's an opportunity for us because there's not very many good capital providers in microcap um it's a den of thieves you know so if we can be the good steward of capital you know call it like the the berkshire of microcap kind of looking at these companies where we have a good reputation, you know, and we'll get good terms because of that reputation, not bad terms for the company and the stakeholders and the employees.

33:58But, you know, so that's how I see it evolving even more in the future. So like in the ideal world, you're getting into a company early and then holding for potentially decades. That would be the goal. Reality is much different usually, you know and so getting back to that anti or that fragile part of small business investing you know the turnover is higher down here you know like you can't apply a coffee can buy and hold forever approach uh down here in microcap you know if you went out and said i'm gonna buy a dozen of these microcaps and you know not look at them again i mean you'll lose all that money in two or three years you know the the reality is the shelf lives of these companies are shorter.

34:44The winning that happens in it, even the wins that we have are fleeting. It can look like a small 20 million revenue company gets a$10 million DOD contract. Well, great. It shows 50 % growth in the next four quarters. Management wasn't good enough to replace that with another one, let alone get two of them. So it shows growth the next year. And so you see this spike in the revenue earnings, you know, for a period of time, most of the people that are coming into the stock feel like that is repeatable. They put it in their spreadsheet, 50 % growth for the next 50 years. You know, this is going to be the next, you know, whatever it is.

35:23And then they get hit in the head with a hammer, you know, once they realize like, no. And so that is more of the typical win in microcap is a microcap company that has a winning season of two to eight quarters. And so our average hold period is probably around 16 to 18 months. The goal is to find things that we can hold forever. But the reality is very few will meet that hurdle. And the irony of that is I think you've, and we deal with these small, fragile companies. The irony is, though, that you see that even in the best stock pickers, the best investors in the world that invest in large caps or mega caps.

36:05I mean, you can look at Warren Buffett at Berkshire Hathaway and everybody just feels like he buys and holds everything. Well, no, you know, he's owned hundreds of companies over his career, hundreds. And today he owns 10 for over 10 years. So a small fraction of what he's owned over his career, he still owns. And then a small fraction, he owns more than 10 years. So the best investor ever had to kind of churn through or have turnover of hundreds of companies to find a handful worthy of owning long term. And you multiply that by a small company, obviously turnover is going to be part of it. And even somebody like me who thinks they know what they're doing, I probably have owned 90, 100 stocks over five or six years, and I've owned one for over five years.

36:55you know and so it's tough you know that's the goal but your success is probably more about finding those ones that even have a winning season you know and and and executing on those investments correctly getting in the right price getting out at the right price the execution side of it and so selling is a very important skill with micro cap investing how do you think you've improved your selling discipline over time. Support comes from Wise, the smart way to manage the currencies you need around the globe. Fed up with losing out to hidden fees when you send money abroad with your everyday bank?

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38:12Gemini and Chrome is here for it. Ready to make anything online make sense? There's no place like Chrome. Check responses set up required compatibility and availability varies 18 plus. I feel like the selling skill is one that I've been pretty good at, mainly because of how I got started in story stocks. you know story stocks um i was probably in each one for three or six months and i knew back then all story stocks need to raise money every six months or nine months or 12 months you know to keep the lights on and keep telling the story and so my goal was to get out before the next financing and usually when a financing occurs in microcap you know it just puts a you know a ceiling on top of that equity price in fact it goes a lot lower um and so because of that i had to be attuned to selling.

39:05I had to be okay with selling. I didn't have any anchoring biases towards the management teams, even though I met with them. I had to be willing to sell and stay rational. And so the selling part of it is something that I feel like I've been decently well at. And even my, again, if you look at microcap investors, we all invest differently. I have my way of investing in them, you can still find deep value investors and stuff like that down here. But for me, you know, I put in a lot of management reps, you know, with the companies that I own today and companies I don't own today. And a lot of the advantage of that has nothing to do with what people might be thinking, well, you know, they're telling them things they shouldn't be telling them.

39:50You know, that's why he wants like, no, it's not that it's just, you just pick up on body language, you pick up on things. It's just like, you know, how you don't, your wife doesn't have to tell you that she's angry at you. You just know by the way she looks, you know, she didn't have to tell you. And it's the same thing with anybody you're building a relationship with, you know, you can tell something's changed, you know, and that's why I put the reps in with management teams. And it might not be the first or second or third time that it becomes an advantage, but by the 20th time. You can sense if something's wrong.

40:24And I've learned to develop that spidey sense. And that spidey sense, doing this successfully over 20 years, yes, I've had some big wins. And those reps allow you to keep your conviction high and the ones that deserve it to get more of the gain. But a majority of it was just picking up on the signs and clues that something cracked in the thesis. And it probably came from a management discussion where just something fell off. And that spidey sense that you get, or at least that I have, has been pretty accurate. You know, they don't, I can just tell. And then you know not to wait around, to wait around and see if you're right.

41:04You know that 85 % of the time when you've seen this, you should be selling. And so you sell. And so that's where kind of a combination of my management reps and selling, at least in an asset class or investment class like microcaps kind of goes hand in hand as well i mean like we could probably do a whole episode on this topic potentially but like when companies are in that refinancing inflection point like is that management also has to have discussions with the people who refinance them and then maybe they pick up on what you're picking up on? How does the people who provide the capital, how do they even evaluate whether they want to refinance a company or not at that size?

41:55I mean, it's difficult. I mean, again, the way I've evolved since then, I'm not a pure story stock investor. I would call myself more of a growthy GARP investor now, where most of the companies I'm investing in are profitable. They don't have to raise money. They might desire to raise money for a growth purpose, you know, but they don't need to, to keep the lights on. So those are two different kind of, um, segues there. So for the ones today, Ben granite, you know, I still have a couple of story stocks that are pure story stocks in the portfolio because I kind of view kind of investor maturation, if you will, you know, I started out as story stock and then I went to resources in the mid two thousands, kind of gold, silver, you know, junior exploration, which I guess are still story stocks.

42:41And then kind of went to GARP, you know, really focusing on fundamentals and then focus on life sciences. And so like the portfolio today, kind of look at the evolution of an investor is you're trying to learn to paint with all these different colors. You know, in the first five years, you might only know how to paint with one and you express that with your portfolio being all in that one color. You know, and today hey, my portfolio, I can paint with 10 different colors and it took me 25 years to do it. And so I still have some pure story stocks in that portfolio, but it's not all the portfolio.

43:14And so that's predominantly kind of how I view the kind of the maturation of all this. But on the financing side today, with the companies that we normally look at, it's usually not situation where they need to raise money. It's more of a conversation with me or I have people in my network that I trust that we might co-invest with them. And we're not talking about a lot of money. We're talking about like$1,$2 million. It's not like$100 million or something like that. And you get a good shareholder base. And at the same time, people that are kind of like me, where you're not looking to flip out in the next three months as long as they perform.

43:50That totally makes sense. So that's really cool to get insight on how you do it. Do you think social media has created a breeding ground for more story stock stories? do you think it's or is this like this the same thing that wall street has always seen like there's just always places for story stocks and investors can get caught up in it or not yeah i mean i think i think there's there's always a theme you know if it wasn't ai it was 3d printing or you know there's always something you know um and then there's some themes that go in and out of favor whether that's mining or or whatever you know a lot of those cyclical industries that obviously are coming in and out of favor based on the underlying commodity price going up or down.

44:36So I think there's always going to be story stocks. And quite honestly, when you think about VCs, and that's the thing, one of my biggest pet peeves is there's three types of small business investing. There's venture capital investing, private equity, and everybody loves those two. We read them in the headlines every day and all these famous people and podcasts and stuff like that. And then there's micro cap investing, which no one ever talks about favorably. It's just like the sleazy, slimy, you know, surge of, you know, the small business investing world. And it's really not, it shouldn't be that way.

45:12You know, it's like, you look at actually the facts of, all right, well, let's go back a hundred years. And the best performing market cap decile is the smallest decile over the last hundred years by like 300 basis points, you know, just the small decile of companies. Huge outperformance. If you actually look at illiquidity as a factor, which Roger Ebbetson of Yale used to put out an annual white paper on illiquidity, and he would divide up the investment stock universe. And he looked at since 1970, comparing large cap liquid companies, large cap illiquid, mid cap liquid illiquid small, and then microcap liquid illiquid the the little box that had the highest return over 40 years was illiquid microcaps by like 200 basis points so that's where the outperformants comes from um and so you kind of layer all these things and you look at most of the best stock pickers ever from buffett to greenblatt to lynch to all these people that you and i look up to all started in microcap you know for a reason because the inefficiency down here and that structural inefficiency has been in place for 100 years.

46:20And that structural efficiency is the fact that these are too small of companies that are too illiquid for these larger pools of capital to participate in. I mean, there's not even any ETFs. It's because these companies trade$10 ,000 a day. How is somebody managing 100 million or more going to invest in a basket of these companies? They don't. And that's why the opportunity is for the small, smart, astute investor. if you're starting out, it's still the best area to invest in. If you're willing to put forth the work and do the primary research it takes to be successful, if you're just looking to subscribe to some guru service and get your picks somewhere, that's not going to work.

46:59You got to do the work yourself and learn from your mistakes and you're going to lose money. But on the other side of that hard work and losses probably is going to be some incredible opportunities if you just stick with it. But you have to do the work yourself because there's no analyst coverage anyway. So you have to do the primary work. So what would you say is maybe one of the biggest mistakes an investor can make that's specific to micro cap investing? Could be general as well, but maybe there's one that you feel is amplified in this space. I think I hit on it already, but I do think like the biggest mistake is probably focusing in on the story stocks at the onset, you know, cause I think a lot of people, unfortunately their first entree to microcap investing is either something gets directly emailed to them or through gets in their mailbox through snail mail about some pump and dump that they get and call themselves the next Amazon and you buy a little bit of it and it goes to zero.

48:00I mean, I actually used to collect, I used to have an Excel spreadsheet of the pump and dump hard mailers I would get in my mailbox, my physical mailbox. And I would have the spreadsheet. I think I had like 45 of them and I would track the performance of those. And literally all of them went down 99 % on average, like within a year, you know? And so a lot of times, unfortunately, like that's the first entree people get to microcaps is penny stocks, which is kind of the derogatory term for this space. And then they don't want everyone to look at it again, you know? And it's because it was just that bad first taste in their mouth, you know, because of that.

48:34But it's a, it's a very good place to invest if you actually care about valuation and fundamentals, just like any place to invest. You just, you know, you just don't buy something you get in a magazine. So. That's funny. Yeah. Or, or seen on social media or something. Yeah. I'm going to flip the question you then like what skill can be cultivated the most to produce alpha um is it management or can it be something else um i think all the skills can be cultivated i feel like i've gotten better you know with all all the skills of sort of stock picking which you know i think the first one is identifying um and that's the the skill of finding actionable ideas before others you know and that's something where I think in today's day and age of social media and X and sub stacks and stuff like that.

49:31I mean, there's tons of people that are even combing the universe for microcap investing. Obviously, microcapclub.com, I created that in 2011 to be basically an idea generator. You know, get all the best investors in this niche and on one platform and talk about what you like and why. And so I think places like that can be helpful, you know, but idea flow or increase the amount of idea flow means nothing if you don't know what you're looking for. You know, so you have to know kind of what you're looking for at the same time. I do think, you know, buying is an important skill and buying and basically just means for me, like sizing your conviction at the onset of an investment.

50:11Like what's your position size? What's your initial position size? And I think that's something you figure out where you sit, over time, not maybe immediately up front. When I first started out as investing, even when I was a full-time private investor, I was mainly in four stocks, super concentrated. Today, I'm in like 15. And so things you're allowed to evolve, allowed to grow. And a lot of times with these small microcap companies, when it comes to initial position size, if you get the right ones and you're right, it really doesn't matter whether you make it a 5 % versus 15 % at cost position, you know?

50:50And so you're better off to almost making it smaller than you want to be. And that's something I've learned as the capital has grown. And I feel like my batting average is getting better. So adding a few more positions or a few more chances to win to the portfolio helps me versus hurts me. You know, then holding is another skill that again, just takes time takes 10 or 20 years to to just get good at holding which i define as maintenance due diligence it doesn't mean doing nothing it means constantly reassessing the thesis you know against reality of what the numbers are showing and what management is saying and that's a full-time job it's just maintenance new due diligence on the portfolio and that's how you stay invested and that's how you sell quicker than others is when you spot those signs which we talked about with the management teams.

51:44And then obviously selling we talked about already, but I feel like that's an equally pivotal one, especially in microcap. And each one of these skills, they can be, whether the type of investor you are in microcap or whether you're not even a microcap investor, some of them are used or underused depending on your flavor of investing. Like if I was a deep value investor, I might not care as much about management quality or putting in the reps with management because I can just do a screen for below book value or something like that. But what you find, ironically, is even in areas like that, like deep value, which you would assume that when you actually, which has been a struggling factor over the last 10 years, like value or deep value underperforming.

52:31But what you find is like you can still find deep value investors that are outperforming. I have a couple of good friends that match funds and their deep value and they're 22 % CAGR through this whole cycle. And you're like, what are they doing? Guess what? They're doing something. They're doing something different. And like one of them, he's a deep value investor, but he also values management quality. So he still goes out and visits. He still does like that. And that's, that's what you learn too over time is it's not the areas that you are the same as other investors. Oftentimes the alpha is in the areas that you're different, you know, than other investors and especially in your flavor of investing.

53:08yeah that's fascinating what do you say to the investor who's maybe just starting out they hear all of these things that they have to learn and they feel a little bit overwhelmed what do you say to that person well i just think you you just start you know if you want to be an active investor most of the best active investors started in microcap because they were forced to do the work themselves. And I think that independent mindset forming independent conviction from whatever everybody else is saying is the key to outperformance. And you just can't be afraid to get in there and just start learning.

53:49You know, just like there was a tuition bill for your college. You know, there's going to be a tuition bill that comes with losses over time. But you're also going to have wins too, you know, and you know, it's a game of batting average and slugging percentage in every facet of stock picking. And the best stock pickers in the world, there's a great book written on this called Stock Market Maestros and the Art of Execution. Lee Freeman Shore is the author. And he analyzed, he was a fund to fund. So he put$2 billion with the top 40 hedge funds, some of the very famous ones you see on CNBC. He said, all right, 20 million to this one, 40 million to that one.

54:32And he tracked and he gave them one instruction. He said, I only want you to invest in your top 10 stock ideas with my allocation. And he tracked it for 10 years. The best stock pickers in the world that are institutional. And I think the hit rate across that 10 year period, which means what percentage of the stocks that they bought were winners versus losers was 49%. So a coin flip, whether they made money or not on an idea, And the whole purpose of that book was, you know, it's all about what comes after that initial purchase, you know, how you handle that position, the averaging up, averaging down, selling, all those other things executing on that idea is what creates the alpha.

55:16Because there's obviously people that have 40 % hit rate that still outperform, you know, and things like that. So that's all I would say, too. Like, you can't even I know what I think I know what I'm doing. And if I'm at 55%, that means 45 % of the time I'm wrong. And you can't let the ones that you're wrong on deplete your courage to act on the next opportunity or the act of bettering yourself as an investor.

55:44It sounds trivial, but I think there's a lot there. Investing with fear can really be troublesome. So this has been a fantastic conversation. we just started scratching the surface on the skills I know this is something you cover in your book the book again is Stock Picker it's being released September 15th I believe yes it is so this will go live right around that time pre-order it if it's out there what would be your encouragement to a beginner of like why should they read Stock Picker Well, I think if you're intrigued with small companies that become large companies, you know, and 87 % of companies globally that have gone up 10x or more over the last 10 years were micro cap companies.

56:43You know, they weren't actually just NVIDIA and Tesla. You know, 87 % were micro caps. And guess what? 91 % of those micro caps were profitable. so if you're interested in where the alpha comes from in the public markets and you know most of the best stock pickers started here most of the best performing public companies of all time originated as microcaps from monster beverage to you name it intuitive surgical um if you're intrigued by that and you also are intrigued with the pursuit of financial independence which was a big part of my life, really my career and the study of great leadership and just pulling out some other lessons like that are around those topics.

57:26You know, I think you'll, you'll enjoy reading the book. Yeah. Highly recommend it. You've got a great X account as well. So people go follow you there as well. Ian, thanks for joining us. Thanks for sharing your knowledge and check out Stock Picker. That's going to do it for today. Remember to invest with a margin of safety Emphasis on the safety We will see you next time Peace

57:55You've been listening to the Investing for Beginners podcast All show notes can be found on our website At einvestingforbeginners.com To master the basics of stocks in seven days Sign up for our free email series at einvestingforbeginners.com slash newsletter. Until next time, have a wonderful day. The information contained is for general information and educational purposes only. It is not intended as a substitute for legal, commercial, and or financial advice from a licensed professional. The hosts may own positions in the securities discussed. Review our full disclaimer at einvestingforbeginners.com.

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