The Microcap Frontline- 2016 Recession, OTC Hunting And The Best Kind Of Microcap Stock Is...

| About: Precision Auto (PACI)

Summary

What should microcap investors do to if we are going into a recession in 2016?

Dropping screeners and going through OTC listed stocks one by one can have very good advantages for the microcap investor.

Did you know that classic rock lyrics have hidden/subliminal investing messages?

The best kind of microcap stock really depends upon your own personal style.

I've always done things that were different from the majority or mass. In elementary and middle school, I use to read books during recess, class events/parties, etc. In high school my hair was blue and my clothes were alternative, to say the least. Overall, in my whole life thus far, I have wanted to be the black sheep in a herd full of white ones. Maybe it is because I am an INTP. Or maybe it's simply because doing what everyone else does is just plain boring.

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Source: The Refined Investor

So what does dying my hair blue and being a black sheep have anything to do with investing? Take a look around you. The investment landscape is filled with individuals buying, selling, researching and writing about the hot stocks of today; Apple (NASDAQ:AAPL), Twitter (NYSE:TWTR), Tesla (NASDAQ:TSLA) and Facebook (NASDAQ:FB) to name a few. These companies are looked at, revisited and written about on the daily.

To me, writing, researching and investing in Fortune 100, 500 and even 1000 companies is boring, due to the heavy research dilution present (everyone looks at these companies). Not only are these companies boring, but if I studied these companies, I would be going against what I have been doing my whole life; doing the opposite of the mass. Researching microcaps makes much more sense for my personality and helps me per se, be a black sheep.

Today market pundits are afraid and do not know what is next. Here is a quick recap of 2016 so far…

The market is crashing!

We are headed into a recession!

Sell, panic, prediction, ahhhhhh!

Source: Jantoo

When I read and listen to this market noise of the market I think of the following lyrics by Creedence Clearwater Revival

"I hear hurricanes a blowing. I know the end is coming soon. I fear rivers overflowing. I hear the voice of rage and ruin. Well don't go around tonight, well it's bound to take your life, there's a bad moon on the rise".

The S&P in 2016 is down this much. The Russell 1000 is down this much. Oh my god, we better sell and find a different profession. Maybe psychology would suit us well (I know the majority of investment professionals should learn more about their brain and psychology rather macro and everyday movements). In fact, knowing psychology may be one of the most important aspects of a successful investing career. But what do I know? I am just some 20 something kid.

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Source: Town Square Buzz

What am I doing in the face of a crash and a negative environment? The same thing that I have been doing; researching, investing and writing about microcap companies. Oh but don't microcap companies fall harder and faster than the broad and larger market due to an increase in volatility? Not necessarily. First, there are some microcap companies that are so thinly traded that they don't even move with the general market. This is due to high insider ownership.

Think about it, insiders know their company. They know what drives revenue. They understand the industry. And most importantly, they understand how long-term gains are created. Why would an insider who knows the company up and down, sell in the face of every panic? Here's a goal for you; find a quality microcap and learn as much as you can about that company, as if you are an insider. I believe your perception of market movements will change if you do the former.

Yes, there are a lot of microcap companies that are highly volatile compared to the other larger counterparts. However, if you are a long-term investor, using volatility to your advantage is a very smart move. Especially when a high quality microcap presents itself with a great buying opportunity. An increase in volatility does not mean a certain security is more risky, at least for long-term investors. Take advantage of those pendulum swings. I can't stress that enough.

Sometimes there are hidden investing meanings in songs. Take for example these song lyrics

"Don't let the sound of your own wheels drive you crazy. Lighten up while you still can, don't even try to understand. Just find a place to make your stand and take it easy".

Don't let everyday movements of the market drive you crazy. Don't even waste your time trying to understand the overall short-term market movements. Make your stand in a certain investment or investing and stick with it. Don't let the market movements dictate you.

Were the Eagles subliminally giving out great investing advice? Probably not. But let's entertain each other and say that they were.

My Plans Going Forward

Screeners are great. I utilize them weekly. One screener I was using was the Acquirers Multiple. However, I recently cancelled my subscription to it. There were two reasons for the cancellation. First, I've wrote about and studied pretty much every company on the Microcap Acquirers Multiple Screener. Secondly, I felt like I was becoming dependent upon the screener as an idea generator.

I believe that screeners are a very useful tool for the equity analyst. However, I also feel like screeners have flaws as well. The first flaw is that you become dependent upon that certain screen. You're like a horse with blinders on; all you see is what is in front of you. Secondly, there are some items that screeners do not capture such as customer brand awareness and popularity, good management and other qualitative factors/functions.

Finally, screeners are limiting. What I mean by limiting is that you plug in your metrics and boom, there are the companies that meet those metrics. No more, no less. Now I am not trying to bash screeners, for they are a very useful tool. All I am trying to say is that an investor can become dependent upon the use of a screener and it becomes a type of crutch.

So what's my plan going forward since I am dropping the use of screeners…at least for now? Well, since I am such a nice guy and I don't think there will be an increase in competition in what I plan on doing (from me announcing my plan), I will let you in on my 'Grand Master Plan'. My plan is to go through the vast majority of OTC listed companies, one by one.

So far going through OTC listed companies one by one has been a great learning experience and actually very rewarding. In fact, I have already made a list of potential investable securities that have a very good chance of generating alpha. I may be a nice guy, but I am not going to share that list with you…at least without a price. Let's start the bidding…just kidding.

However, I will share with you a company I found on the OTC boards that I wouldn't have found using a typical screener. The company is called Precision Auto Care (OTCQX:PACI). The thesis is a pretty simple and easy one to understand. Back in 2008, the company went dark and in the mrq they have relisted to the OTCQX exchange. Furthermore, revenues are growing at a decent clip, FCF and earnings are positive, balance sheet is strong, management is shareholder friendly and the current valuation is skewed due to one-time charges.

It's a pretty hidden microcap gem that many market participants probably don't even know exists. What I find fascinating is that the company has >315 locations on a domestic and international basis and I am sure a good chunk of the population has gotten their oil changed at one of these locations. I've recently gotten my car looked at, at a PACI location, and let me tell you, they do quality work.

What is interesting is that the majority of individuals see microcap companies as more risky, obscure and filled with scams. The former three points do have some truth to them, however, there are a lot of quality microcap companies out there. PACI is a good example of a quality microcap, with a real business and very real potential of upside/alpha generation. Here is a detailed report I wrote on PACI for the investor interested in learning more about the company.

I don't think many investors are going to sit down and scan through OTC listed companies one by one. It's a pretty decent task to say the least. Although, investors who like research, reading and have patience, will certainly be rewarded going through these hidden gems one by one.

And the best kind of Microcap is…

That's kind of an arbitrarily worded questions. It all really depends on your overall investment style and goals. Some microcap investors I know focus exclusively on deep value and NCAV stocks. They are not looking for an investment where they can hold and compound for years. They are looking for that one last puff. That puff that can generate excessive and market beating returns. Cigar butt puffing is a good style and a great way to generate alpha. However it's not for everyone.

Another microcap investing style is the growth investor. This investor finds companies that he or she believes controls a great niche product, with potential to capture a substantial amount of market share. Typically, this investor doesn't care if they are paying a high multiple, for they are hoping the company is cheap on a forward basis though substantial growth. Furthermore, this investor is also known for averaging up on an investment as the thesis continues to play out. I feel like I am least like this type.

There are a significant amount of investing styles in the world of microcaps, so arbitrarily stating what the best microcap is complex and impossible. I can tell you my favorite kind of microcap though. To me, a great microcap is a company that has a significant margin of safety. I look for companies where if I took them private today, I would make my money back in 2-3 years. A 2-3 year breakeven return is a great margin of safety to me.

Second I like to minimize risk. Risk to me is not mark-to-market losses. Risk is a total capital loss. To minimize a total capital loss, I focus on companies with strong balance sheets. Typically a company that has more cash than debt is preferable. Another way to minimize risk is to find companies that have positive FCF. Thus if a company can continue to pump out strong FCF with a significant margin of safety, well you could say that's my kind of company.

I also like to find companies that have a niche product or competitive advantage. One way to find these kind of companies is by looking at their historical ROC or ROIC. If a company has posted high returns on capital or returns on invested capital for an extended period of time, well that's a good suggestion that they may control a competitive advantage. However, you should note that high historical ROC and ROIC are not a definitive yes that a certain company has a competitive advantage. It takes a lot more digging than just screening for high returns on capital.

Finally, I look for a strong management team. Currently I am constrained by lack of capital, so I can't just travel across the country and visit companies (one day though). Although, you can get a feeling of a good management team by going through filings. A few suggestions of a good management team are; high ownership, low take home salaries, low to no previous dilution, high buyback programs and special dividends. Also picking up the phone and giving management a call can give you some suggestions on the competencies of management.

Finding a company that is undervalued, with a high margin of safety that has low balance sheet risk, controls a niche market /competitive advantage and has a good management team is challenging and quite the treasure hunt. However, it is possible and I have found companies with these attributes. If you want to know some of these companies, go back and read some of my past reports.

Conclusion

Being able to think independently from the crowd is very important in this profession. Not worrying about overall market movements is also an important ability for an enterprising investor. Furthermore, patiently buying and holding high quality microcaps is not as easy as it sounds. If you are one of my followers, going forward, you will start to see more publications on no name microcap stocks that you probably have never heard of. Take some time out of your day and study one of these companies I bring into the limelight.

To end this piece I would like to leave you with a comment from one of the most intelligent commentators I have ran across on SA, Insider-Alerts.

Source: This Undervalued Nano-Cap Company Deserves A Second Look Due To Heavy Insider Buying

Follow Insider-Alerts, read/study his comments, and push for him to publish an article on SA.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.