In his latest Q3 2020 Letter Dave Waters, founder of Alluvial Capital, provided some great insights on how investors can find bargains that fly under the radar. Here’s an excerpt from the letter:
Companies that are small for good reasons often begin to grow larger over time, enriching shareholders in the process. They introduce new products and services, perform smart acquisitions, and adapt to changing business environments. Companies that are small for bad reasons tend to stay small. They muddle along, failing to earn their cost of capital year after year, they recommit to ineffective strategies and fall farther behind competitors, or they fight a hopeless war against dire industry trends.
This is not to say investors cannot make money in fundamentally flawed or challenged businesses. At a certain price, virtually anything can be cheap. However, I have found it much easier and less psychologically stressful to make money by committing capital to high-quality small companies with motivated, well-incentivized management, sound strategies, and growing end markets. The best part is getting this quality for free! Buying the highest perceived quality large companies almost always meaning paying a steep premium.
Investors aren’t stupid. But the market routinely overlooks or ignores high quality tiny companies, which allows me to pay single digit multiples for cash flow streams growing at 15%, 20%, or more, backed by strong balance sheets and quality leadership.
Investors sometimes labor under the impression that in order for a business to generate excellent returns for shareholders, it must invent some revolutionary product or process or otherwise upend an existing industry or business model.
Certainly, many of today’s tech darlings have done so. But there is another path, one that gets fewer headlines but the same outcome. This path is to pursue a conventional business model, offering a product or service that already exists, but do it better. I don’t mean to sound trite.
It’s easy to say, very difficult to do. But over time, firms that figure out how to deliver a better customer experience, be it price, convenience, service, or any other factor that customers value, will tend to take market share from competitors and build customer goodwill.
You can read the entire letter here:
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