SELB - Buy And Hold Coffee Can Portfolio For The Next 15 Years
2023-03-16 13:38:32 ET
Summary
- This article covers topics from Christopher Mayer's book "100 Baggers."
- The book is based on studies by several economists and fund managers who have used strategies to uncover 100X opportunities over time.
- Many of these discoveries were back-tested with investment results coming from a buy and hold strategy of small, profitable companies.
The "100 Baggers" Book
For those unfamiliar with Christopher Mayer's little gem of a book , 100 Baggers Stocks That Return 100-To-1 And How To Find Them , it's a short and very stimulating read. "100 Baggers" is loosely based on another book, 100 to 1 by Thomas Phelps, that studies the same topic: where were the 100 X opportunities lurking? Hindsight is 20/20, and most of our knowledge about $10,000 investments turning into a million or more have to do with studies and parables rather than our portfolios.
Looking through some of the advice in the book, I've put together my "coffee can" strategy to find stocks with 100 bagger qualities to stick in a can and bury for 15-20 years. Please join me in this experiment.
Qualities of a 100 bagger
The Mayer book points out that historical 100 baggers have qualities that can follow the acronym SQGLP:
- S-Size is small.
- Q-Quality is high for both business and management.
- G-Growth in earnings is high.
- L-Longevity in both Q and G.
- P-Price is favorable for good returns.
The qualities remind me of qualities brought up in Joel Greenblatt's book and Magic Formula screener . Both in books and podcasts, he has noted that back-tested methods examining small-cap stocks that had the highest scores for ROIC (return on invested capital) and earnings yield, usually resulted in the highest absolute returns over time. The screener he created with his team at Gotham to trawl the market can be set to look for stocks of all market cap sizes, all the way up to mega caps only.
Joel Greenblatt's Magic Formula
I am close to having a semi-regular series covering value stocks that rank highly according to this methodology. If you would like to browse a couple of previous high-score articles that went on to wallop the market thereafter, they can be found here and here . What follows is a synopsis of how the value formula works.
The metric used in Magic Formula/Little Book investing is quite simple, it takes all the stocks in the stock market, minus banks and utility companies (since their growth is regulated), and scores them by combining their earnings yield and their return on invested capital. The two percentages are added together and a score is derived from this. The earnings yield is calculated by dividing the earnings per share by the share price. He believed the earnings yield gives a better metric than P/E as values more positive are better, while in P/E a value of smaller proportions is better when analyzing the "cheap" part of the equation. There must be two "positive is better" metrics to add together to produce ascending scores.
The earnings yield is then added to the ROIC %. An example would be a stock with an EPS of $10, and a share price of $100. $10/$100= 10% earnings yield. This would then be added to the ROIC. If ROIC was also 10%, then the stock would have a total score of 20. The higher the score the better. The screener allows you to set the market cap threshold from $50 million up to infinity.
While I like to set it to large caps to avoid excess volatility, the coffee can portfolio should follow the 100 Baggers rules for the market cap size. It should also be purchased with an amount that you can set and forget for years on end. This screener satisfies the 100 Baggers metrics, high growth and quality in the ROIC metric, great entry price via high earnings yield, and small market cap size. The L, longevity of those earnings' growth factors, can only be realized by holding into the future.
The list
Below is my current list of small caps under $1 Billion that are the highest-scoring small caps in the Magic Formula screener for March 2023. The Earnings yield was derived by calculating EBITDA/EV courtesy of Yahoo Finance and the ROIC data is TTM courtesy of YCharts .
Out of the top 50 stocks in the entire market, these were the top stocks I could find that had market capitalizations under $1 Billion. These 26 stocks had the most accurate data for both of the scores I was looking for, EY + ROIC. The rest of the 50 on the list had market caps over $1 Billion as of current or inaccurate data.
Hidden magic
Another aspect of 100-bagger hunting that analyst Thompson Clark shares with Mayer in his book is the case study on Amazon.com, Inc. ( AMZN ). It looks at how to uncover fast growers that show negative GAAP EPS, possibly on purpose, to grow revenue at a faster clip. Thompson went through Amazon's 2014 numbers and had the following commentary:
Looking at Amazon's reported operating income, it doesn't look profitable. On $88 Billion in 2014 sales, Amazon earned a measly $178 million in operating income. That's a razor thin .20% operating margin.
Adding back R&D, however, paints a completely different picture. In 2014, Amazon spent $9.2 Billion on R&D. Adding that back to operating income, Amazon generated adjusted operating income of $9.4 Billion in 2014. That's an operating margin of 10.6%.
One of the major reasons why myself and other authors are hot on Google ( GOOG , GOOGL ), Amazon, Meta Platforms, Inc. ( META ), and Microsoft Corporation ( MSFT ) has to do with their consistent ROIC combined with R&D expense, which is not entirely necessary to run their businesses. Thompson goes on to say about Amazon:
There's some component of R&D that is essential to keep Amazon going, but there is also a growth component that helps generate future sales.
When looking at small companies or large that have a significant component of R&D, it's worth examining how much is needed to stay competitive. If you determine it's more of a tax shelter/growth tool than a necessity, the exercise of adding back R&D to operating income amongst small caps could be very worthwhile.
R&D per stock list 1:
R&D per stock list 2:
R&D per stock list 3:
The above charts are a bit all over the place, but we can see as of current who is spending money on this expense item and who is not. The highest spender of the bunch is Selecta BioSciences, Inc. ( SELB ), with $72 million. Many of these are small biotechs that now have products and have to spend on R&D. 100 Baggers points out that there have been a few great biotech 100 baggers, with Amgen ( AMGN ) and Pfizer ( PFE ) being the most notable.
SciPlay Corporation ( SCPL ) is a notable stock with $46 million in R&D and not in the biotech field. They are a mobile gaming company that has been growing. Although mobile gaming and gambling apps may seem like small potatoes now, don't doubt that companies that have high returns on capital can pivot into larger fields like Monster Energy ( MNST ), the company used to sell apple juice, did. Given enough time, 100 Baggers shows that well-managed companies can surprise you over time.
Highest scores
Centrus Energy Corp. ( LEU ), Co-Diagnostics, Inc. ( CODX ) and Unit Corporation ( UNTC ) have the highest scores on the March 2023 Magic Formula list at over 100 each for small caps, let's see what they do via Yahoo Finance Profiles:
Centrus Energy Corp
Centrus Energy Corp. supplies nuclear fuel and services for the nuclear power industry in the United States, Japan, Belgium, and internationally. The company operates through two segments, Low-Enriched Uranium [LEU] and Technical Solutions. The LEU segment sells separative work units [SWU] component of LEU; SWU and natural uranium components of LEU; and natural uranium for utilities that operate nuclear power plants.
Co-Diagnostics
Co-Diagnostics, Inc., a molecular diagnostics company, develops, manufactures, and sells reagents used for diagnostic tests that function through the detection and/or analysis of nucleic acid molecules in the United States and internationally. It offers polymerase chain reaction [PCR] diagnostic tests for COVID-19, tuberculosis, hepatitis B and C, human papillomavirus, malaria, chikungunya, dengue, and the zika virus; three multiplexed tests to test mosquitos for the identification of diseases carried by the mosquitos; and molecular tools for detection of infectious diseases, liquid biopsy for cancer screening, and agricultural applications.
Unit Corporation
Unit Corporation, together with its subsidiaries, engages in the exploration, acquisition, development, and production of oil and natural gas properties in the United States. It operates through three segments: Oil and Natural Gas, Contract Drilling, and Mid-Stream. The Oil and Natural Gas segment explores for, acquires, develops, and produces oil and natural gas properties. Its producing oil and natural gas properties, unproved properties, and related assets are primarily located in Oklahoma and Texas, as well as in Colorado, Kansas, Louisiana, Montana, New Mexico, North Dakota, Utah, and Wyoming.
Put it in the coffee can
A small amount can go a long way even if some of these small caps fail. I don't own all of them yet, but intend to put together a nearly equal-weight portfolio at some time this year, possibly higher-weighting the stocks with the highest dollar amounts of R&D. Buying is easy, the psychology of waiting is harder.
Summary
The book this article is based on is excellent. The case studies are consistent and prove that buy-and-hold strategies of very profitable companies can result in generational wealth. Not being tempted to liquidate shares of companies at perceived highs or perceived lows is the psychological key. If you believed they were high quality in the first place, why not hang on for the long haul?
I am also throwing coffee can classics into a bigger can with the current deals on Amazon, Google, Microsoft and Meta. Expecting a smaller long term return, but certainly a very nice one over a long period.
I like some of these bets on the list more than others, but you never know what a company with good management will morph into over time. I much prefer this approach to buying a Russell 2000 ETF. Good luck and I hope to provide updates on this strategy in the future.
For further details see:
Buy And Hold Coffee Can Portfolio For The Next 15 Years