- We hunt for small-cap stocks with the potential to return 100X over a 5- to 10-year period.
- Using both quantitative and qualitiative approaches, we identify and build long positions in selected US small cap equities.
Inspired by Christopher Mayer's 100 Baggers and Thomas Phelps' 100 to 1 in the Stock Market, we hunt for small-cap stocks with the potential to return 100X over a 5- to 10-year period. The approach is to sieve out companies with consistently high return on equity and gross profit margin and with management who are owner-operators with skin in the game. They should demonstrate a strong track record of successful capital allocation, by growing sales and maintaining high profit margins, or through stock buyback to reduce the shareholder base (at the right price).
We therefore developed a quantitative model to rank all US small-cap stocks with market capitalization of between $200M to $2B, based on their 5-year average return on common equity (with a 30% weightage), 5-year average gross profit (30%), 5-year revenue CAGR (8%), along with other metrics such as levered free cash, EBITDA CAGR, quick ratio, interest coverage ratio, debt-to-equity, cash-to-total-capital ratio and non-free float shares.
Source: Libertus Research
The motivation for this quantitative scoring model was to uncover the next wave of businesses that exhibit potential in growing exponentially to be the next mid- to large-cap stocks.
The questions that we subsequently apply to companies identified from the quantitative model are:
- Does company show potential for revenue growth and 100X appreciation (through both earning growth and P/E re-rating) driven by any of the following:
- Growth initiatives or pathways to scale into enormous Total Addressable Markets
- Validation with good customer reviews & growing revenue, positive employee review and/or rapid job creation
- Does company demonstrate strong earning power and is able to generate a lot of free cash, demonstrated through the following:
- Earning or pricing power
- Sales growth
- Profit margins
- Build-up of book value/ cash reserves
- Does company have a leadership or dominant position in the industry and/or demonstrates potential to be among the leaders with:
- High barriers of entry
- Clear competitive advantages over competitors
- Does company have a strong balance sheet and ideally minimally or no debt?
- Does management have a track record of strong execution, preferably with high insider ownership?
- Is the company a target of short sellers and/or we believe that the problems identified by short sellers are untrue/ manageable?
Finally, the size of our position depends on the price-valuation gap, after we price the risks identified in our research of the stock.
Based on the above, we have started to screen, identify, buy and sit on a selected basket of small-cap stocks that we believe could return 100X over a 5- to 10-year period. We will be writing and sharing our findings with the Seeking Alpha community to battle-test our ideas.
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