(Ep.75) The Acquirers Podast: Paul Andreola – Canada Micro – Public And Private Investing, Small And Micro, And Tech

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In this episode of The Acquirers Podcast Tobias chats with Paul Andreola, Founder and Editor at Small Cap Discoveries, and he’s currently ranked number one in the MicroCapClub. During the interview Paul provided some great insights into:

  • Finding Multi-Baggers In Micro-Cap Stocks
  • Successfully Investing Using William O’Neil’s CAN SLIM® Investing System
  • If You’re Trying To Create Wealth You Have To Be Concentrated
  • Sometimes The Best Investments Don’t Have An ‘Investor Relations’ Department
  • The Best Opportunities Can Be Found In The Most Obscure Places
  • You Only Need To Find One Or Two Stock Ideas Earlier Than Everyone Else
  • If You Know You’re Wrong, Exit Your Position
  • The Real Inventor Of RealNetworks
  • Front-Running Institutional Investors
  • Brokerage Firms – Not All They’re Cracked Up To Be
  • Pre-IPO Investing

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Full Transcript

Tobias: Hi, I’m Tobias Carlisle. This is The Acquirers Podcast. My special guest today is Paul Andreola. He’s the founder and editor at Small Cap Discoveries. And he’s currently number one in the MicroCapClub. We’re going to talk to him right after this.

[intro]

Hi, Paul. How are you?

Paul: Tobias, I’m doing great.

Tobias: Congratulations, first of all on climbing to the top of those rankings. The last person I had on was Maj Soueidan. Before I got him on, you’d already taken his place. So, I also have to ask and start, are you still not the one?

Paul: I am. Yeah, I maintained it for a couple months here. So, we’ll see. You’ll probably have a new guest next month. We’ll have to see.

Tobias: It’s highly competitive. It seems to– [crosstalk]

Paul: It is.

Tobias: –regularly.

Paul: It is. Yeah. Well, that’s the nature of the micro-cap business. Penthouse one time and outhouse the next time.

Tobias: Yeah, value investing has been in the outhouse for a long time. I haven’t been to the penthouse for quite a long time.

Paul: [laughs] You’ll get there, just keep hanging on.

Finding Multi-Baggers In Micro-Cap Stocks

Tobias: It happened like more than a decade ago now, but it’s been a long time between drinks with deep value guys. Tell me a little bit about Small Cap Discoveries.

Paul: What we have is, it’s a hybrid between a newsletter and a bit of an investor’s club. What we do is, we’re trying to find those anomalies in the micro-cap, I’d even say nano-cap market. What we probably do is really find these odd little companies based solely in Canada. Right now, all we do is we look for, sort of scrounge around the Canadian public markets and try to find companies that fit the criteria that I started to use over the last 25, 30 years. And finding these, they call them 10-baggers, 100-baggers, whatever you want to call them. Companies that typically go undiscovered for years, and then for whatever reason, something starts to happen, they become discovered and with a little bit of luck, they turn into pretty good investment wins.

Tobias: So, what do you look for?

Paul: A number of things. We use a bit of GARP principle where we’re trying to find growth companies, but really at early, early stages, right at some form of inflection point. One of the key things we look for is companies that are growing at least 25% per year or greater from a revenue basis, on a per share basis, which is important. We’re trying to find these hyper-growth companies that actually have some real fundamentals behind them, profitability, or at least some real visibility to profitability. And we’re trying to find them before the industry or the market finds them.

We’ve got this checklist that we use that we– ideally a company will check off most of the boxes and if it does, we’re fortunate enough to hold on to some of these, then they turn out to be pretty significant winners.

Tobias: What’s on your checklist?

Paul: Well, like I said, revenue growth is the first thing we screen for. [crosstalk]

Tobias: What period of time just before you– over what kind of– [crosstalk]

Paul: The more the better. We’re measuring year over year. If we see a company come out with a quarterly statement that shows that revenues have grown 50% over the same period last year, that starts to get us interested. Over and above that, it’s been doing that for several years, and all the other criteria still fits our list, then that gets us even more excited. A good example, and one that has really worked out for us was a company called Xpel Technologies, which had actually had probably eight or nine quarters of just fantastic growth, and yet the stock had never really gone anywhere. So, we were fortunate enough to capture that early enough and had these back-to-back quarters, and literally turned out to be 100-bagger from where we started buying it.

Tobias: That’s amazing. I think I’ve had a few smaller micro-cap guys. I think Connor Haley also had a position in Xpel. When did you discover that and how did that play out?

Paul: I discovered it when it was roughly about 17 to 20 cents. I think now, the last I looked at it– I’ve since sold it, but– I think it’s trading about $15 or $16. That would have been five years ago. I can’t remember exactly when, but it was early on for sure.

Tobias: Is that a Canadian company? You’re exclusively Canadian?

Paul: Well, exclusively Canadian listed. Xpel actually used to be listed in Canada. There’s a number of companies down the States that’ll come up here in the list because of the structure of the IPO market here. Yeah, so that was one that headquartered in San Antonio, Texas but listed here, had toiled in obscurity up here for years. And it just kept growing its business, and then eventually left the Canadian market and now it’s exclusively trading down in the States.

Tobias: So, they can be US companies and they’re taking advantage of that lower listing standards. Are they’re going on to the Toronto Venture or something like that, or they’re on the main board?

Paul: Yeah, so TSX Venture, yes, the Toronto Stock Exchange venture is a component. I would argue actually that the listing requirements themselves are about as onerous as any in the world. The way the industry is set up here, I think it’s more conducive to funding like very, very early stage companies. And I think that was the big draw for a while. But, yeah, they’re scrutinized the same as any other company. But, yeah, the TSX Venture is, I think, what you’re asking, that’s right.

Tobias: So, the idea is rather than raising venture capital say, you go and you can get [unintelligible [00:06:46] distributed shareholder base by listing in Canada. I’m familiar with that a little bit because it’s a similar process in Australia. I think they can get listed [crosstalk] listed or no, it’s just there’s a less mature maybe venture capital market there, so they tend to list at an earlier stage.

Paul: You’re dead right. That’s exactly it. I’ve actually worked with the TSX Venture Exchange and doing a lot of roadshows to try to entice companies to come up here and list. And that’s just it. An early-stage company has got a couple options, and one is venture capital. I think what’s happening now more with venture capitalists is they are looking for the next unicorn, so it’s less likely to get funding from one of these big VCs. If you don’t meet that benchmark, you’re left to struggle and try to find angel investors. The TSX Venture Exchange is sort of that secondary option. But that being said as well, the venture capital market in Canada up until a few years ago, I would have said is extremely immature, not really able to properly fund a lot of these companies. So, the TSX Venture was really the only option, especially for a Canadian-listed company to get any kind of capital that they really needed.

Tobias: That venture capital money, there’s a lot of fishhooks in it. You’ve got to grow at a really rapid rate to hold on to your equity in those when you take that home.

Paul: Well, that’s true. And the other issue too is, if you have any sort of stumble, that’s when it gets really dangerous where, if you’re publicly listed, you’ve got some capital and it’s typically distributed capital, so there’s not one person or one group that says, “Okay, because you didn’t hit your benchmarks this quarter, you’re ratcheting back.” Exactly. There’s some real viable reasons why it makes a lot of sense for some of these startup companies.

***

Tobias: What’s your background? You’ve been doing this for two or three decades you said. What were you doing before you were writing the newsletter? How long have you’ve been running the newsletter?

Paul: The newsletter self, I think it’s about eight or nine years. Prior to that– I’ve got no formal education in the investment arena. I studied construction management back in the early 20s. But I’d always had a passion for investing. I bought my first piece of real estate, I think, when I was 18, 19 years old. I bought my first stock, I think I was 19 years old. But no formal background there. It really was a trial by fire or school of hard knocks. That being said, I actually worked in the construction industry for about seven or eight years, found that I really hated it. So, went to back to my hobby, which was investing. When I was 17, 18 years old, I pretty well read every book you can imagine that was available at the time on investing, and started dabbling and doing okay, nothing crazy, but really learning early the some of the issues.

***

Successfully Investing Using William O’Neil’s CAN SLIM® Investing System

Then what happened was, eight years into construction and just breaking my back and hating getting up in the morning to go to work, my wife at the time had said, “You’re miserable. Find something else to do.” [chuckles] What I decided to do is, I quit my job. At the time, the internet was finally out there. I wouldn’t say day trading, but I started investing and using some of the tools that I learned from different books, and there were certain books that really stood out for me. I started using those tools and started investing on my own. And then, there’s a couple of events that triggered some real changes in what I was doing, and most of them were books. I remember reading William O’Neil’s How to Make Money in Stocks.
.
Tobias: Is that CAN SLIM?

Paul: CAN SLIM, exactly. Prior to that, I’d be going down the library. I try to review company filings, and not having a clue what I was doing really. I was just trying to find companies and investing in some idea that I thought just sounded good. The reason I even found out about CAN SLIM was, I had entered a stock-picking contest, and there was probably easily 1,000 people that are in this contest, and I think the prize was $100,000 portfolio. This bank-owned brokerage firm was going to give whoever the winner was $100,000. So of course, that was incentive for me to jump in there.

I think over the course of the six months, this relatively short contest over six months, I came in like 56 or something like that over 1,000, which I thought was impressive. But the guy who came in first just blew everybody out of the water, like second place wasn’t even close. They interviewed him and he said, “I had a little strategy.” And they said, “What’s the strategy?” And he said, “Well, literally all I did was I bought whatever stock was hitting a 52-week high and it was trading close to $1.” And then they would ask him “And then what?” And he goes, “No, that was it. That was it.”

And I go, “What? I did all this hard work. I studied and did this and this that.” And then like I said, well, it was based on a principle that he learned out of CAN SLIM, which if you know CAN SLIM, the 52-week high is a critical component which blew my mind because it was always– for me, prior to that was, you’re going to buy something cheap, you don’t go and buy something expensive. It just doesn’t make any sense.

So, I read the book, I probably read it over three or four times, and I said, “Okay, well, this sounds crazy, but I’m going to try.” And lo and behold, I started trying it and the performance of my portfolio just went crazy. It literally went from maybe averaging 10% to 15% a year, it’s like 100%, 120%. I go, “Okay, something’s going on here.” But because I’m based in Canada, [unintelligible [00:13:18] Canadian market, I tried to tailor it a little bit to the Canadian market. There’s some nuances in Canada that’s a little bit different in US. Stocks typically traded at a lower sort of price point. There’s different stock structures. There’s not as many micro-cap funds, things like that. So, I started to understand the industry a little bit more and started to formulate CAN SLIM to more of a Canadian model. When I did that, my performance really went crazy.

I’m working at home, I’ve got a small portfolio, I’m starting to grow this portfolio and my dad who is so anti-stock market, it was crazy, and he was convinced. I left my 9 to 5 job and had started trading stocks.

Tobias: You we’re just gambling.

Paul: Gambling. He thought it was just full of sharks and crooks, and you name it, which it is. But I was making money and he couldn’t believe it. He said, “Well, listen, I’ll give you $10,000, do that for me.” And I did, and he started making money. So, the next thing what happens is he’s telling his friends and other members of the family. And before I knew it, I had seven or eight accounts that I was trading for. The deal was, I would get a percentage of whatever the winnings were. So, I started opening up more and more of these accounts at this brokerage firm and thinking, “Hey, this is great. I’m actually making money. The world’s perfect.” I get a phone call from the brokerage firm saying it was their compliance department saying, “What are you doing? Are you licensed to do this?” “I said, No, of course, I’m not licensed to do this. I’m doing this on behalf of my family.” They said, “Well, you can’t do it if you’re not licensed.” So, of course, next thing in my head was, I’m going to go get licensed.

Brokerage Firms – Not All They’re Cracked Up To Be

I became a broker. And of course, once you’re a broker, you can’t get a percentage of the performance. [chuckles] So my income went from way up here to way down here, because I was just generating commission now. So that’s kind of it. I got into the brokerage business that way. As a matter of fact, I really struggled to even get in because they were only hiring people with MBAs, and I found a little, I’d almost say bucket shop now, it’s not really around anymore. But they hired me because I phoned every day until they finally got sick of me calling and had me join. I joined the firm.

And what was interesting is I had developed this strategy that was working, and I’m this young guy coming into this brokerage firm full of about 100 different brokers. And I used to think that the brokerage industry was this sort of gilded doors and these are all the smart people and these are the guys that have studied this stuff and have a PhD in economics and you name it. I got in there and I was blown away how chaotic and unprofessional and how poorly– [chuckles] it was crazy.

I was actually the first person there to request financials. At the time, I was actually buying a lot of US stocks, and I would go to my boss and say, “Hey, look, I need to find quarterly statements on this company.” And they wouldn’t know what to do. They had no idea almost what that meant. At that time, this is how bad it was, if I wanted quarterly statements on a company in the US, they would have to send a request and wait for it to be mailed in. [cut audio] literally mailed a set of financials. I moved heaven and earth, the internet was just around that time. And I moved heaven and earth to finally get an internet connection to the firm and this way, I could access financial statements over the internet.

Slowly, surely what started to happen is, as I was doing this and I was finding these little companies– and this is at the early, early stage of the tech boom, I’d say early 90s, for sure. Others around me started to see what I was doing. And before you knew it, as soon as I would go and place an order–because at the time you have to go and run an order into the desk, and I would see my order get placed, and immediately right after that, there’d be a bunch of other orders coming in from my firm. Somebody was tailing me on everything I was doing.

Overtime, I got a bit of reputation for having found these weird companies but the performance we were generating was astronomical. I can easily count in the hundreds how many stocks that we’re buying that were going up four or five times in value over the course of a year, it was crazy.

***

Modifying CAN SLIM For Canadian Stocks

Tobias: What are the rules of CAN SLIM and how did you modify them for Canada?

Paul: I can’t remember them all because it’s been a while since I’ve read the book but you’re looking at things like stocks hitting a 52-week highs is a real big deal there. You want to buy hypergrowth, so the 25% growth or higher, both in revenues and earnings. You want to look for new things, new management, new products, new territories, new something. CAN SLIM, they want to see very low institutional ownership. That was something that was really novel to me. Same thing up in Canada. And there’s a few others, but the other ones I’d say are almost not as important.

One of the big ones for CAN SLIM is you don’t buy anything less than $10. Well, in Canada, at the time, there were probably only a dozen stocks that were trading over $10, I’m being a little sarcastic here a bit. That was one of the big modifications, is any price for me– it was regardless of price, if it met the other criteria, you’re jumping on. There’s no institutional ownership in Canada at that time until the stocks were getting into the $100 million market cap and higher, but I was looking everything sub-50 million.

Front-Running Institutional Investors

So, little nuances like that. I didn’t care if there’s institutional ownership at all. More times than not, there wasn’t. The price was the big one. I would look at a stock. If it was at 50 cents, that didn’t bother me at all. They were looking for volume. It’s criteria that was something that I didn’t care about it all, the more illiquid, the better. So, it’s just those kind of modifications. It wasn’t dramatic, but it was things that are just a little bit more tailored to the Canadian side.

Tobias: Is the idea behind the absence of institutional ownership that they will buy in the future, so you’re kind of front-running the institution?

Paul: That’s exactly it. One of the benefits I had from being a broker was actually understanding the industry more than any sort of tips on how to buy stocks. It was really understanding what motivates every component of the brokerage or institutional industry. The biggest criteria when it comes to a lot of these funds is the size of the company. If they’re managing a billion dollars, they’re going to be– it’s very unlikely you’re going to be buying a sub-$50 million market cap because it just never going to– the numbers just don’t match up to make it worth your while.

So, what I noticed while I was doing a lot of buying in the space was that these companies would grow at a certain pace and there’d be very little interest until it just hit a certain market cap. To this day, it’s still a little bit like that. You see the $50 million point and $100 million point, and as you go higher, just see these different levels. And what I was noticing is as soon as a certain company met this certain market cap, you’d see a bunch of buying, you’d see a bunch of volume and the change in the activity around stock. It was just so obvious. And then I was finding out, what was happening is it was hitting that criteria that some of these micro-cap funds were able to buy and they would buy them because there was so few things they could buy and you see this just rocket ship in share price. All of a sudden, you go from– and you toil between 20 cents and $1 and then at $1, it goes like straight up to 3. And you go, “Whoa!” All I can think, I just want to be a couple steps in front of that, and that’s what we started doing and it worked like a charm.

Tobias: I’m a little bit familiar with the share price idea as well because in Australia, the listing price minimum is 20 cents, I think, and if you come out at $1, you’re really making a big statement about what you think your company’s– not that it’s silly, because you can set it anywhere. What’s the minimum listing price in Canada and [crosstalk] listing pricing in Canada?

Paul: Yeah. I mean technically about five cents. Five cents would be the minimum listing price. You don’t really see too many companies get listed at five cents. You can see most of them somewhere between 20 cents and $1 when they get listed here. The TSX Exchange was the senior exchange in Canada, so that’s a little bit different animal. There’s not really a price requirement like there is on NASDAQ or some of the other exchanges. But there is certain tiers and it almost depends on how frothy the market is. If the markets really frothy, we’ve seen the bubble, marijuana and blockchain and things like that, you tend to see the price get the– IPO price is a little bit higher. And when things were really slow, you’re going to see them lower, but ultimately, it’s all about market cap.

***

Pre-IPO Investing

Tobias: You would list publicly quickly and privately?

Paul: Yeah, I mean I’ve done a fair bit in the private space. I’m kind of agnostic. Really, what I’m looking for is certain criteria in a company and of course the price. What I’ve found over the last little while, quite frankly, is that I’m finding cheaper valuations in the public markets than in the private market. So, if that’s going to continue, I’m going to predominantly be investing in the public market. We’ve been involved in helping some companies go public that have the criteria we look for. And when the public [unintelligible [00:24:12] to flip around the other way, it’s a great opportunity for arbitrage, you’re finding companies growing at say 25% a year and it’s got a valuation of five times earnings, the market tends to give you almost at a minimum, 10 times earnings. So, there’s an arbitrage there.

We were seeing opportunities a few years ago where literally all you have to do is, you take one of these private market valuations, you take it public, and there’s your arbitrage. You’re making money. But it’s this weird dynamic right now where it’s flipped around because of this crazy VC private money, you’re starting to see actually private equity coming into the micro-cap space, because they’re finding better deals in here, and I’m seeing it.

Tobias: You’re investing with a view to an IPO? Is that the idea?

Paul: Yeah. Everything is still levered off the public markets. I say I and we, I sort of interchange it. We’ve got a bit of a network of investors now that follow what we do or do what we do and we try to spread as much opportunity around as we can, but we know the effort that it takes to take a company public and what you need to make it all work. If we can bring that to the table, we will. Otherwise, I prefer investing in already public companies.

***

The Real Inventor Of RealNetworks

Tobias: You’ve got two, MDU TV and Destiny Media. Can you talk about those two companies?

Paul: Sure. So, those are the two I’m willing to admit about. There’s another private company that I was involved with that, I’d almost say, was a disaster but it had a lot to do with timing. MDU TV, it was a startup actually. After I was in the brokerage business, I actually got tired of business because I love my clients, but I hated having clients. It was a weird circumstance. My personal portfolio was making me more money than my day-to-day job of being a broker. So, I finally said, “Okay, this is not making a lot of sense.” Plus, I was getting just a little tired of the day to day and the issues around being a broker. I was asked to help on a startup, so I left. I decided to leave the business. And my job was basically raise money. Because I had been in the business, I was going to raise money for this little startup.

And what we’re doing at the time was, it was really the advent of satellite television as a replacement for cable TV in urban areas. Predominantly, satellite TV was going to be for rural areas, but we had a business model where we can come into a high rise or a large residential complex, and cable the unit for satellite TV and it turned into a mini cable franchise. We did that. In Canada, the cable franchises were so dominant. The most hated companies in Canada were cable companies. And we had this idea we’re going to displace some of that business, and we set to do that. So, we raise a bit of money privately and started our business, and then we were approached by someone, it wasn’t me, but somebody else approached and said, “Well, why don’t you go public?” And we said, “Yeah, let’s go public.” And it was just before the dotcom or the tech boom. It just caught fire. It was a little company that we started. I think we took it public at 25 cents and within a year the stock’s at $10.

Tobias: Wow.

Paul: But mind you, the business is growing. I remember still sitting across from the founder at my kitchen table and we had actually sketched out the business plan. There’s no employees, it went from zero employees to 150 employees in probably a year and a half. The business just exploded. But it’s also pre-internet days. So, I was fortunate because I was able to see all the dynamics around almost like a mini unicorn where we went from zero to 100 miles an hour in no time and got all the benefits of that. Management took over, I was really redundant very quickly because they’d raised money and my expertise was pretty well useless at that point.

So, I left that business, did very well by it, and then started another company called Destiny, again, with a couple of founders. My role was to help them raise money and steward them around. This time, our [unintelligible [00:29:09] was really going public as quick as we could, which we did. Back in those days, my gosh, we’d still argue that we had the first streaming software platform in the world, that the found had actually sent a version of this little– the founder actually used to work at Electronic Arts, and him and his partner had developed this ability to play video games with each other remotely and be able to speak to each other while they’re doing this.

This was unheard of at the time. We took this little bit of software and we said, “Well, we’re going to change the world. We’re going to be able to broadcast radio and TV and everything.” He came up with the idea that he would send a version to Microsoft to see if Microsoft had any interest. I think he still has it, but he’s got a framed letter from one of the engineers at Microsoft saying, “This is impossible. It’s not possible to stream audio over the internet.”

Of course, about six months later, Microsoft comes out, RealNetworks comes out and that business goes absolutely crazy. We were left in the dust. But fortunately, we just pivoted, like good startups do. And the company’s still around, but, boy, we were at the heyday of streaming business, and with a little bit of luck, it would have been a lot different.

Tobias: Where’ the stock price now?

Paul: I think about $1. It probably gotten up to the equivalent of $20, I don’t even know if it’s– [crosstalk] I left it a long time ago as well. I went on to greener pastures. I think I’ve got an attention span disorder or whatever, [chuckles] two to five years is what I likely last.

Tobias: Pretty good story though.

***

Paul: Yeah, great story. Those are the two success that I like to talk about. I learned a lot from that, that’s probably the biggest thing that’s happened to me. But then, there’s a third one that I don’t brag about, but it’s just as educational. We put the band back together from the MDU days and we had different technology that will allow us to use the electrical system in a building as your internet network. It’s called broadband over powerline. We put all the same management pieces from MDU days, and we’re going to go out and show the world how to properly do this. That was 2007. We had raised a whole bunch of money, and we needed to raise a whole bunch more. Of course, this little thing called the financial crisis hit and basically went to zero overnight because we couldn’t raise any more money which we had to keep the business going.

Tobias: Does the technology work?

Paul: Oh, it works great, but now there’s better technology. Now, you really want as much fiber as you can. The issues around that technology, it’s been improved so much with other technologies that– it’s pretty antiquated now.

Tobias: That’s very interesting. I’ve heard of that idea before, but I wasn’t aware that was actually– I thought it was just one of those things that they used to raise money– [crosstalk] [laughter]

Paul: No, it works. It’s amazing how fast technology advances and you just don’t know what’s coming, but fiber at that time was– well, you’re only going to lay fiber where you really need big traffic, you’re not going to use it close to home. Of course, now we’re seeing– as a matter of fact, another company I’m heavily invested in is doing fiber to the home. It changes so fast. That’s one of the dangerous areas you’ve got to be on top of it, otherwise you get blown up pretty quick.

Tobias: I saw that a little bit in Australia. I worked in a telco that did dark fiber and they were doing fiber to the– many times doing fiber to the node and it was unnecessary to do it to the home because even though we’re using twisted pair coax for most things, the technology on twisted was always getting better as well. That was getting faster and faster, so it just wasn’t necessary to run the fiber all the way into the home, which is clearly like exponentially more expensive than just running to the node.

Paul: It is, but what’s happening is now whoever owns that last mile of fiber actually owns that customer. Especially in the UK, you’re seeing– they’re tripping over themselves trying to deploy as much fiber right to the home because once you’ve captured that– think of Netflix and everything that’s going on right now, the amount of data that is being pummeled to the end consumer is massive and it’s growing so fast. The good thing about fiber is, now if you’re going to improve on the last mile, you want that highway built as big as you can already, and that’s the advantage fiber has over– Fiber has other advantages over twisted pair and some of it is just the maintenance cost, it’s significant lower. There’s all sorts of reasons but [crosstalk] all sorts of things. Exactly. Yeah.

***

You Only Need To Find One Or Two Stock Ideas Earlier Than Everyone Else

Tobias: Let’s go back to the way that you’re investing now. What’s your screening and search process? How are you finding these ideas? I saw in the note that you sent through to me, you read every single filing. How many companies are listed in Canada?

Paul: Thousands. I’ve lost count of how many there are, but it sounds worse than it is. I’ve been doing it for so many years that I can see a name right off the bat and I’ll know a fair deal about the company already. But what I do is, I take myself a cup of coffee or a beer, depends on how the day is going. We’ve got SEDAR– in States, it’s EDGAR, but SEDAR is a repository of all the filings. Every day, there’s a set of SEDAR filings. I’ll review the financials that are posted that day. I’m quickly scanning. I open up the file, and I’ll notice pretty quickly if it’s that 25% growth rate or not. And if it isn’t, I’m on to the next one. So, literally within 15 seconds, I can tell if I really want to look any deeper. So, that’s what I do. I do that every day. Some days are bit heavier than other days, depending on time of the quarter. And then, a couple of times a year, what I’ll do is I’ll just review all of them.

The beauty in this business, you don’t need 100 investments. You’ve got to find that one or two and if you find it early enough, that’s it. That’s what I’m constantly looking for is that one or two that just fits the bill. Sometimes, they don’t quite fit all the criteria, so I’ll put it on a watchlist and I’ll keep following until a few things come to place, and then I’m off to the races. The one thing I’ll note is that I hate– not that I hate, too strong a word, but I don’t use any screening software. The reason why I do it manually is because every now and then one– I’m not always that crazy about the data that goes into these screening software packages. But every once in a while, one falls through the cracks, and that’s the one you want. So, if you’re going to find that one that falls through the cracks, you’ve got to do the work to go and find it.

And Xpel was an example. Xpel was a weird little circumstance where it was actually a Canadian-listed company but trading in US dollars. So, it had a dot you suffix to the symbol, and for whatever reason, it just didn’t screen well. It didn’t screen in most screening packages. So, it was a great example of, if I was doing it like everybody else was doing it, I would have missed an absolute beauty.

Tobias: When you find an idea that’s worth pursuing, how do you prove it up? How do you validate it?

Paul: That’s a good question because just finding the financial criteria gets me started. Now, a lot of times what will happen is if it meets the first three or four key pieces, I’ll actually start buying it. And then I get a sense of liquidity, I get a sense of a little bit of market reaction. I’m not super keen on technicals, because so much of that with illiquid stocks can be influenced so easily. But I will start to go through another set of due diligence process. And that’s where my experience in the industry comes to bear. I’ll look at things like share structure, who owns the stock, how it was financed, who financed it, who are the significant shareholders. Then, you look at things like how’s management compensating themselves and how they’ve been with share rollbacks or share splits.

Sometimes The Best Investments Don’t Have An ‘Investor Relations’ Department

There’s a whole bunch of other factors, but they’re not necessarily quantitative. They’re more qualitative. I’m always trying to find a reason not to own the stock now. And the nice thing about owning a little bit is personally, I tend to do better due diligence once I own the stock before I own it. I’m now more motivated to really go and find all the warts because a lot of these micro-caps have a lot of warts on them. And I’m just trying to find every little bit of information I can.

And other things like, a lot of times I’ve already established a pretty big position before I even talk to management. When I do talk to management, some of the questions I ask are– they find it odd. But I want to know how many people have called them, like how many investors call them. I’ve got this great story where I found this little tiny company and got the receptionist and my question always is, “Listen, I’d like to talk to whoever handles your investor relations.” She said, “Okay, hold on a minute.” It probably took her five minutes to get back, and she came back and said, “I have no idea what you’re asking me.”

Tobias: [chuckles]

Paul: “I have no idea who that would be.” [chuckles] So that got me excited. I spoke to the CEO. I got another gentleman that I work with that was helping me out with due diligence here and he called as well. We both call and we were like the first two people to have called him in like two years. And he was convinced that we were actually his competitor, trying to find out about what he was doing. So, when he finally found out that we weren’t competitors and we were crazy little micro-cap investors, he really opened up and it was cool. But, yeah, that’s what gets us excited when you hear that you’re the only one that’s really looking at the company.

***

If You’re Trying To Create Wealth You Have To Be Concentrated

Tobias: When you find something, you’ve proved it up, you like the opportunity, how do you think about sizing an initial position? How big do you want it to be in the portfolio? How many names have you got on at any one time? How do you think about that sort of stuff?

Paul: I think I take a different approach than a lot of other investors. I really believe that if you’re trying to create wealth, you have to be concentrated. If you want to preserve wealth, you have to be diversified. I’m still in wealth creation mode. There’s no set number. If I find something I really like and I continue to believe it’s undervalued and my modeling, my due diligence keeps proving that, I’ll keep allocating capital to it until something happens. Either the model breaks down or stock starts to go where it’s supposed to.

At any one time, I’d say– the bulk of my portfolio is probably made up between five and eight names, but I might have a whole bunch of others that are sort of that small starter position, where I’m just trying to try to see how much more capital they should get. The analogy I use is like a sports team, a baseball or hockey team, where you want to keep your best players on the ice, you want to give them as much time on the field as you can. But you also want to keep watching who is on the bench that’s looking good and you want to replace someone.

One of my sell criteria has less to do with what an individual company is doing and more with what other opportunities are presenting themselves. All that sort of stuff comes together, and it dictates how I make up the portfolio. I had circumstances where one stock could be 60% to 70% of my portfolio and it doesn’t flinch me in the least because again, I truly have conviction in the business and the value and prepared to prove it out.

***

If You Know You’re Wrong Exit Your Position

Tobias: How do you know when you’ve made a mistake and what do you do in those circumstances?

Paul: I huddle up in the fetal position and cry myself to sleep.

[laughter]

Paul: It happens more times than not. It’s to be expected, especially in the part of the market where I’m at, you’re going to have companies that completely just crapped the bed. You have to almost price that into everything you’re doing to begin with. More times than not, I know the company almost better than anybody else out there, so that’s my advantage. I’ve got to see if there’s some little headwind that’s coming, I’ve got to see that in advance, and I’ve got to be prepared for that.

Like anything, if I see something going wrong, I start to exit a position. If I see things starting to turn around and right up again, then I might add to position again. But look, if I’m wrong, I’m going to lose money, end of story. I just try to see it as early as possible and adjust the sale so that I can take it, do what I need to do to get out of it.

***

Tobias: Do you have any view on the strategy itself on a transition between private and public, depending on which is offering a better opportunity? Do you have a view on whether the strategy is getting played out?

Paul: So, you asked about the strategy, when it works and when it doesn’t work. I noticed that it almost like it’s cyclical. This works really well when there’s not a bunch of other– I call them bubbles. This is didn’t work well. In Canada, we have– you guys have down in the States as well, the big marijuana craze for a while. It’s shiny object. All of a sudden, investors run from one thing that’s working and run to the one that they think it’s working better, so they’ll run out there. As far as the performance side of it, the strategy doesn’t work well when a lot of other things are working because capital just goes to where it wants to go. But the buying opportunities present themselves better in those times.

So, you get those ebbs and flows all the time. There’s always some new shiny objects and you’ve always got that. But what I’ve noticed over time, because I’ve been doing this for so long, it seemed a lot easier way back in the day, because I guess it was a little more difficult to get access to information. I think now almost any investor has the same tools I’ve got, so they can get out there and find out about these companies at the same time I can. So, it’s a little bit more competitive there, but, yeah, it’s cyclical to some degree. I think it’s working now.

For me, it’s not so much I’m trying to predict what’s going to happen in the space. It’s a real bottoms-up approach where I look at every individual company on its own and say, “Okay, it’s either cheap or it’s not cheap. I’m buying it if it’s cheap. If it’s not cheap, I’m not buying it.” Doesn’t matter what’s happening or where we are in the cycle, it’s got to make sense.

I avoid market noise. I avoid trying to predict where the market’s going. I have a very hard time trying to pinpoint whether the markets too expensive or too cheap. Everything is really an individual case-by-case basis.

***

The Best Opportunities Can Be Found In The Most Obscure Places

Tobias: Do you have any preferred industries or sectors or anything that you avoid?

Paul: Yeah. Things I avoid for sure, we stay out of the extraction business. We don’t do anything in mining or oil and gas or anything like that. We look for businesses that have some sort of repeatability. We’ve invested in everything from engineered wood products, software, biotech– biotech is too strong a word because that’s tends to be a little bit too binary. Healthcare, a lot of healthcare stuff. And then what we’re finding is the best places are these obscure little, almost niche markets where there’s no real industry. It’s just some company is developing something so new that it doesn’t have an industry.

Xpel is a great example. When I found it, I didn’t even know this stuff existed. If you don’t know Xpel, they manufacture paint protection film for your car. The first time I saw it, I never heard of this stuff before. So, what industry is that? Okay, it’s kind of in the auto industry. Anyways, it was bizarre. Now, it’s a semi-big niche industry. So, I try not to get too caught up in what they do. I try to get more caught up in the numbers and have the numbers prove business up.

Tobias: Yeah, it’s absolutely fascinating. If folks want to get in contact with you, Paul, what’s the best way– or follow along with what you’re doing, how do they go about doing that?

Paul: Well, smallcapdiscoveries.com. That’s our website. Really easiest way is just send me an email directly. They can send an email to paul@smallcapdiscoveries.com. Send an email, I’d love to talk stock. I think that’s one of the things that probably my wife thinks I talk too much about. So, yeah, if anybody’s got any questions, especially any questions around the micro-cap space in Canada, there’s very few things or few companies, I at least have some knowledge about that, all that small-cap. I’m on Twitter. Yeah. It’s @PaulAndreola, you should be able to find me there.

Tobias: I’ll link it up in the show notes. Yeah, absolutely fascinating discussion. Really appreciate the time. Paul Andreola, Small Cap Discoveries, thank you very much.

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