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The most lucrative part of the journey lies in micro caps

Gino Rossi
— 1 minute read

Holding high-quality businesses for the long-term is something most investors have an appreciation for, and rightly so. However, we rarely hear about the benefit of finding those companies early on in their growth phase.

Gino Rossi

While few investment strategies have matched buying and holding a high-quality business, it certainly helps discover the stock in its formative years before the rest of the market finds it.

Let’s look at one of the most successful long-term share market stories in the US, Home Depot. It’s essentially the Bunnings of the US, with 2,291 stores and annual revenue of US$110 billion. If an investor were fortunate enough (or smart enough) to purchase the company at its float price of US$12 on 22 September 1981, and reinvested the dividends until 30 September 2020, they would have earned an astounding 27.3 per cent p.a. However, it was when the company was considered a micro cap that the stock delivered its best returns – it returned 59.5 per cent per annum from its float until it passed US$1 billion in market capitalisation.

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It is often this early success that first gets the market interested in a company. 

There are many examples where companies were initially overlooked, and then went on to become market darlings. 

Staying in the US, let’s look at Monster Beverages. Currently its market cap is around US$47 billion. It’s a business in which The Coca-Cola Company couldn’t resist taking a stake in during 2015. However, the company struggled to keep even one research analyst interested during its early days, while listed as a micro cap. 

At the end of 2004, its market capitalisation was US$367 million, and it had not a single analyst covering it. By the end of 2005, its market capitalisation had shot to US$1.7 billion, and three analysts had decided to initiate coverage. The stock doubled again by 2007, and so did attention from the market. While the stock continued to do well over the years, most investors missed the most lucrative part of the journey – the part when it was undiscovered.

Many stocks slip under the radar until they are large enough to be noticed. Even Amazon had just one analyst covering the stock at the end of 1997, today it has 59. Netflix had only three analysts looking at it by the end of its first year as a listed company, today it has 46 analysts making recommendations on the stock.

I believe global micro caps is a segment of the market that offers unsurpassed opportunity. However, it’s a universe largely left out of far too many investment portfolios.

So, here are two examples of companies in our global micro caps portfolio we think will one day attract much more attention. 

BioGaia 

BioGaia is a Swedish-listed company specialising in probiotics. It has a market capitalisation of US$900 million and coverage from only three analysts. The company holds over 400 patents on bacteria to improve oral and digestive health, a growing field of healthcare as more becomes understood about how the various strains of probiotics work. While the majority of the company’s revenue is currently derived from a product used to address colic in children, we expect a growing portfolio of probiotic bacteria strains with an increasing array of indications. BioGaia’s in-house development is industry leading and it builds on this by conducting clinical trials and marketing its products to key opinion leaders, setting it apart from most other industry players who lack this capability. 

PetMed Express

PetMed Express has a market capitalisation of US$600 million and coverage from two sell-side firms. It is similar to its much larger cousin, Chewy, with a market capitalisation of US$27 billion and coverage from 10 analysts. PetMed Express is an online retailer of pet medication in the US. The majority of pet medication is dispensed by vets in the US. However, this has been gradually shifting online due to improved pricing and convenience of the online channel. The advent of COVID has supercharged this transition, but despite this, its share price has underperformed of late. Secondly, the company took the drastic step last year to reprice its catalogue to make it more competitive, and we expect strong growth from this lower earnings base. 

When the market sits up and notices companies like these, most investors would have missed the best part on the journey!

Gino Rossi is the portfolio manager of the Spheria Global Microcaps Fund

 

The most lucrative part of the journey lies in micro caps
Gino Rossi
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