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Please Pass the Grits


It is the small, tiny kernels that interest us in this market.

Driving home for the day and away from the market, I was enjoying a few moments alone with my guilty pleasure, sports-talk radio, wondering what all the excitement was for…caller after caller. It seems my hometown Astros had just broken even! Their franchise record stood at 3,508 wins and 3,508 losses. Why in the world are we celebrating mediocrity? Because they had to go on one heck of a run just to get back to even. Sound familiar?

Welcome to the past seven years of the Stock Market for many. Of course, we here know that money flows from the many to the few in any skill game and Minyans have likely experienced much more success. You may not fully realize how much trouble many investors have had. But take it from us, my partner and I spent the past couple of decades inside the world of a big bank and brokerage – many investors have not had much to cheer about lately. And all of a sudden "lately" feels like that "long term" they were told always works.

Nothing always works. Our fearless leader Toddo says it best, when he describes a daily battle between bulls and bears and the resulting grist, falling into the pan of our pontifications and position pages. I'll add a southern twist to the grist and call it Grits. For those who don't get down South much, grits are a finely ground meal of hulled corn kernels. And yes, I'm a money manager whose family grew up on a farm in Texas. Get ready for more baseball and more food. It is the small, tiny kernels that interest us in this market. At some point Wall Street's common prediction that this will finally be the year of large caps will prove correct, they are certainly getting years of futile practice making the prediction.

Over the last five years, the market as measured by the S&P 500, is up a total of 4%, yet has provided a lot of grits that much of Wall Street missed. I fired up my trusty Thomson time-machine and looked at that same period. There were more than 1,300 stocks doubling or better in value. (note: I've excluded penny stocks, micro-caps, and international stocks) If you wanted to really grind it down, you can find 141 stocks inside that same group which rose a remarkable 400% or better while the market was up 4%. Thankfully, we've owned, or still do own, 20 of those 4+ baggers inside our actively managed portfolio of between 60-70 names. I look forward to sharing some of the methods of our madness down here at our little shop in Texas, far from Wall Street. And, that's been two of the keys right there: small and under-followed. Those 4+ baggers in a flat market had a few things in common:

Past 5 Years:

141 Stocks up more than 400%: "The Grits" S&P 500 +4%
Average Market Cap $4.8 billion $90 billion
Net Profit Margin (NPM) 13.5 % 9 %
Current NPM vs. 5 yr. Average 1.7 (i.e. rising) 0.8 (i.e. falling)
Current # of Wall St. Analysts 9 19

For quite some time now, my macro work (that I will detail in future posts) leads me to believe there have been, and will be, severe headwinds to large U.S. stocks. So, one of the four pages (I will hit the other three soon) in my playbook that can work in this game is to own a business unique enough to make your own price and raise it, not take what you can get. Also, your stock needs to be small enough and under-followed enough so that if the business works, buying pressure for the stock can come from funds who do not own it yet, sending it higher even in a flat market. Much of my work centers around buying or selling pressure for a stock while many choose to focus more on supply and demand for the business. Mix the two and you get a tasty treat. I look forward to swapping recipes, and I am a much better reader than writer so e-mail me anytime, and please pass the grits.
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No positions in stocks mentioned.
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