Bill Mann, who oversees small-cap research at The Motley Fool, recently appeared on a podcast hosted by Ricky Mulvey to discuss the small-cap sector.
They explored topics such as:
– Key attributes investors should seek in emerging companies.
– Whether Walgreens is genuinely experiencing a turnaround.
– A rapidly expanding travel company from South America.
For full episodes of The Motley Fool’s free podcasts, visit our podcast center. If you’re new to investing, our beginner’s guide to investing in stocks is a helpful resource. A complete transcript is available following the video.
This video was recorded on September 7, 2024.
Bill Mann: The real potential for finding massive returns typically lies with the smallest companies. It’s a niche market with fewer participants, making it ripe for value hunters.
Mary Long: I’m Mary Long, here with Bill Mann. He’s a familiar face on Motley Fool Money, and in his day job, he leads small-cap research at the Fool. Bill joined my colleague Ricky Mulvey to offer insights into small-cap investing. They discussed why institutional investors often overlook small firms and why retail investors should pay attention, highlighting a few stocks worth considering.
Ricky Mulvey: Let’s dive in. We’ll start with some standard topics before delving into three sectors of small-cap investing tailored for this discussion. We aim for this to be accessible to newer investors because this isn’t about buying mega caps or index funds. These are more volatile waters. Bill, as the director of small-cap investing, what defines small-cap investing to you?
Bill Mann: Broadly, a company too small to be part of the S&P 500 would be considered a mid-cap or small-cap. There’s no strict definition in the U.S., but we generally set the threshold at about $5 billion in market cap and below. The smallest companies in the S&P 500 are around $11 or $12 billion. It’s interesting because we often think of the S&P 500 as comprising 500 large, well-known companies, but if you start examining it, you quickly encounter companies you’ve never heard of. Below the S&P 500, you’ll find even more obscure and smaller companies, which hopefully are growing and succeeding.
Ricky Mulvey: These are territories most stock analysts don’t cover extensively. What makes these waters intriguing to you?
Bill Mann: You want to fish where the fish are, but also where you can gain some informational or analytical advantage. Analysts often ignore small-cap waters because the companies are too small. It requires the same amount of effort to analyze them, and it’s much harder to get compensated compared to analyzing a giant like Microsoft or Apple. Small-caps don’t get much attention, and in a market that I believe is largely efficient, the fewer eyes on something, the less efficient it becomes.
Ricky Mulvey: When evaluating a company that’s under the radar, like Sabre Corporation, what initial checks do you perform?
Bill Mann: Management is crucial for small-cap companies. Who’s at the helm as CEO? I spend considerable time understanding the CEO’s background and the board composition. Is the board filled with the CEO’s friends? The board should represent shareholders, yet it’s appointed by the CEO. Understanding the CEO’s talent, focus, and integrity is vital.
Ricky Mulvey: Does a company’s market cap influence your thoughts on allocation or position sizing, or do you focus on fundamentals?
Bill Mann: I appreciate the form of that question. For me, position sizing is more about a confidence interval. With a giant like Amazon, you’re fairly certain it’s not going to zero, which isn’t the case for most small-caps. The average company lifespan is shortening to 15-20 years. In terms of position sizing, it’s more about risk and reward, and I’m somewhat indifferent to company size, recognizing that smaller caps have greater downside potential compared to mega caps.
Ricky Mulvey: Now, let’s dive into the heart of the episode—the companies. I’ve categorized them into three sectors for this discussion. One is struggling companies, the “knife juggling” segment. Then, speculative “bottle rocket” companies, which can exist in large-cap land but are also prevalent here. Lastly, my favorite discussion with you is about quality, low-key companies quietly doing their thing. Let’s start with the knife juggling. Many retailers are struggling now, and as an investor, you sometimes need to be contrarian. Do you ever attempt to juggle these metaphorical knives?
Bill Mann: As an investor, you mean metaphorically? Yes, I do. A memorable story I often share is about my investment in Denny’s Corporation in the early 2000s. Denny’s lost focus on its core breakfast offering, trying to expand into other meal times unsuccessfully. They eventually returned to their roots, and it paid off. I do like taking risks, but you have to acknowledge that the market often correctly identifies failing companies. The key is recognizing potential value in companies that come close to failing but manage to recover.
Ricky Mulvey: Speaking of companies on the brink, Walgreens is on my radar. I don’t own its stock, but it’s intriguing. Its market cap is about $7 billion, comparable to its value in the mid-’90s. Trading at three times forward earnings, it’s been hit hard by an impairment charge following the Village MD acquisition. The CEO, Tim Wentworth, might be employing big bath techniques as he settles in. The thesis is that the stock’s current value is less than its real estate holdings, and there’s a demand for prescription drugs in America.
Bill Mann: [LAUGHTER] You might have buried the lead a bit there.
Ricky Mulvey: Americans are changing how they get their prescriptions, but tell me where I’m wrong, Bill.
Bill Mann: Initially, I thought you were incorrect in categorizing Walgreens as a small-cap, given its significant drop—about 90% from its peak. You mentioned 1996, and on an inflation-adjusted basis, it’s a shadow of its former self. Walgreens, once a leading pharmacy and retailer, stumbled significantly. Despite substantial challenges, including store closures, there are promising aspects of its business. It’s currently a mess, but I’d wager on Tim Wentworth making a successful turnaround.
Ricky Mulvey: I visited a Walgreens recently, and one shelf was completely empty, highlighting ongoing shrinkage issues. They’re not disclosing shrinkage numbers, which is concerning. Any other interesting turnaround stories on your radar?
Bill Mann: Besides Walgreens, Charles Schwab Corporation is noteworthy. After Silicon Valley Bank’s collapse, people scrutinized other banks, including Schwab, which shared similar balance sheet traits. Schwab experienced significant withdrawals as customers sought higher interest returns than cash holdings offered. Though Schwab isn’t a small-cap, it’s a fascinating turnaround case.
Ricky Mulvey: We’re in election season, Bill. Answer however you like.
Bill Mann: [LAUGHTER] Indeed, we’ll keep our focus on small-cap companies. Remember, some small-cap firms grow into large-cap companies. Let’s explore the speculative “bottle rocket” companies. Investing in these feels like lighting a bottle rocket, hoping it ignites and soars. Bill, is this your kind of game? We’ve talked about risky ventures, but do you dabble in speculative investments?
Bill Mann: Many associate small-caps with speculative growth potential. I engage in this, but I avoid sectors where everyone expects bottle rockets, as these often carry inflated valuations relative to current revenues or earnings.
Ricky Mulvey: I was considering a Space Tech company, but it delayed its earnings filing, and board members started selling shares, raising red flags. AI excitement is also rising, but your point stands—once attention increases, valuations often follow. There’s a biotech company, CRISPR, which recently received FDA approval for a drug curing sickle cell disease. Despite this, investor enthusiasm is subdued. As a small-cap company, has CRISPR’s performance surprised you?
Bill Mann: CRISPR’s gene-editing platform offers numerous therapeutic possibilities. Despite a 75% drop from its peak, some analysts predict profitability by 2026, with potential earnings of $30 per share by 2030. With shares currently around $48, there’s significant potential. However, investor excitement seems lacking, possibly due to previous disappointments.
Ricky Mulvey: I haven’t heard much about CRISPR lately, even with its medical breakthroughs. It feels like a venture capital bet—high risk, high reward, especially in biotech where outsiders often lack insight.
Bill Mann: Exactly. People may be cautious due to past losses. Stock prices reflect future expectations, not current performance. Investors aren’t yet convinced about CRISPR’s potential.
Ricky Mulvey: Let’s move to the quality, low-key segment. No metaphor here—these companies quietly excel without much attention. One is Despegar, a Latin American travel firm. Listed alongside Cracker Barrel and Jack in the Box, it’s an interesting case due to its niche focus. Do you use Despegar for travel?
Bill Mann: Indeed, I have, particularly for hotel bookings in Lima, Peru.
Ricky Mulvey: I’m planning a trip to Costa Rica and exploring Despegar’s offerings. Despite little attention, it stands out. What excites you about Despegar and the Latin American travel market?
Bill Mann: Despegar forms strong relationships with hotel chains, securing block bookings and deals. It nearly faced collapse during COVID, but travel in Latin America is rebounding. Despite currency risks in reporting, its operations remain stable. For instance, they reported 12% revenue growth, which adjusts to 46% when accounting for currency fluctuations. People often overlook this potential due to perceived risks.
Ricky Mulvey: Despegar’s headquarters in Argentina does present some currency challenges, especially given Argentina’s hyperinflation. A concern for me is the lack of insider ownership data. Does this raise any flags for you?
Bill Mann: The co-founder Martin Rastelino holds about $6 million in shares, not insignificant but not substantial either. Insider ownership isn’t extensive, which isn’t ideal. However, they haven’t been offloading large amounts of shares, so it’s not a major concern but not a strong positive either.
Ricky Mulvey: Despegar’s earnings calls are fascinating, full of unique challenges like Brazil’s flooding affecting operations. It’s a company that faces substantial hurdles.
Bill Mann: Indeed, their earnings reports often sound like a series of unfortunate events, but many are legitimate challenges.
Ricky Mulvey: Any final thoughts on small-caps or trends worth discussing?
Bill Mann: I encourage investors to consider small-caps due to the high concentration at the market’s top. The multi-baggers are often among the smallest companies, offering great opportunities where fewer are looking.
Mary Long: As always, individuals on the program may have interests in the stocks discussed. The Motley Fool may have formal recommendations for or against these stocks, so don’t make buy or sell decisions based solely on this discussion. Thanks for tuning in. We’ll see you tomorrow.
