A Quick Question

What’s the worst performing exchange year to date?

China? Greece?

How about Turkey?

Nope. The worst performing index year to date is...

Our very own TSXV:

It’s down 24.3% as of this past Friday. After another 2.1% drop on Monday, it’s clearly in “bear territory”.

Fear has gripped the markets. High beta stocks, especially the once-popular FANG stocks, are leading markets lower.

Investors who can sell are doing it in droves. Those stuck in microcaps are hitting any bids they can. Investors want cash and they want liquidity.

Are the markets finished? You know they’re not. But it sure feels like there is more pain to come. Some facts may help us make sense of it all.

Most markets, especially emerging markets, have been in a bear market for a while now. Long enough perhaps that it’s time to start looking for some green shoots and early signs of the next bull phase.

The US major markets were the last ones left at the party. They were left to turn out the lights. And they’ll probably be the last ones to join the next bull leg when it starts.

But the markets are getting cheaper and the best cure for low prices, as they say, is low prices. Our microcaps and nanocaps space is starting to see some low prices – even some really low prices.

All you need at the market bottom is faith. Faith that the world isn’t ending. I’m not saying we’re at the bottom – but boy some assets are cheaper today then when everyone was a lot more bullish.

Remember the Buffetism…. Be fearful when others are greedy and greedy when others are fearful…. Do you see any greedy investors out there right now?

In the stock market, eventually math (aka financials) matter. We’ve seen several mini bubbles come and go. We’ve had electric metals, cannabis and Vancouver real estate. Remember blockchain? Many of these companies are now out of favor because the fundamentals couldn’t justify their valuations.

Ok another question… what is the best performing stock in Canada this year?

A cannabis stock? A safe utility or bank stock?

Nope. It’s Xpel Technologies (DAP.u.V), up ~325% to date. That’s right... the TSXV is down 25% and Xpel is up 325%. All it did was grow revenues over 69% and earnings 257% this past quarter.

How many brokerage analysts covered Xpel at the beginning of the year? Zero, nada.

How many cover it now? Zero, nada.

How many brokerage analysts cover Canopy Growth Corp (WEED.T)? At least 12.

Return to date? 45%.

Not bad but this is one of the best-known cannabis stocks in this red-hot sector. Billions of dollars have been invested in this space and one of the best returns this year is only 45%.

Why do I bring this up? Because the markets are not here to make it easy for you.

The stocks your friends are buying or the latest fund manager on BNN or CNBC are touting are not usually the ones that give you high returns.

And if you are going to be investing in microcaps you better get the odds in your favor. Outperformance doesn’t come from buying the hottest microcaps. You must learn to be uncomfortable when you buy microcaps. You must feel somewhat alone and crazy. That’s the price you pay for outperformance.

So, what do we do now? It depends. How brave are you? What’s your time frame?

If you can think like a private company buyer and hold for a few years, then maybe now’s the time to start buying cheap companies. No need to go all in. But some nibbling might make sense. Just don’t expect many buyers to join and comfort you.

Some of the best returns I ever had were with stocks I felt like I was the only buyer in the beginning. I’m thinking Covalon (COV.V) at $0.13, Hamilton Thorne (HTL.V) at $0.10 or Photon Controls (PHO.V) at $0.08. It was pretty lonely and scary!

If you’re holding some of these beaten up “cheap” stocks, ask yourself: why did you buy them? What has changed (other than share price)? Is your conviction strong enough to hold on? Maybe even buy more?

Remember this: Maintaining your conviction when investing, like many other situations in life, is the most difficult at the very time it is the most needed.

Several stocks I follow run the risk of being taken private. Some are trading at mid-single digit EV/earnings. The last time I remember seeing this was just after the 2008/2009 financial crisis. That’s when I found Xpel trading around 6 times earnings at a measly $0.17 share price. Now it trades around $6.50.

Because I work in both the private and public markets, I can get a sense of when one market is too cheap or too expensive. Rarely do public market valuations get cheaper than private valuations. But I’m starting to see that now.

Two examples are Vigil Health (VGL.V) and Namsys (CTZ.V). Both are illiquid nanocaps. Both have reported record 12-month trailing revenues and earnings. And both are trading at or near 52-week lows.

Neither can be called cyclical stocks. So why is VGL.V trading at 5.5 EV/earnings or CTZ.V trading at 7.4 EV/earnings?

How many SAAS software companies like CTZ.V are trading at that kind of valuation? Add back the costs of maintaining a public listing ($200,000 - $250,000) and the numbers make even more sense to go private.

These stocks don’t smack you in the face when it’s time to buy them. They sit there quietly going about their business while some shareholders throw them out because they are afraid. Or they get bored. Or they just need money for rent.

Sometimes it’s only a handful of shares – but it’s enough to drive prices down to single digit metrics. This is where the small investors have an advantage over the big investor. These small sell orders are too small and insignificant to impact an institutional investor’s portfolio.

Plus, many of these institutional players are too busy fretting over their cash positions in the event of fund withdrawals or they’re trying to manage bigger positions like high beta FANG stocks.

I’m not claiming to know if this is the market bottom or not. To be honest, I don’t know. And I don’t think anyone else does either.

What I do know is low liquidity microcap and nanocap stocks are starting to look really cheap. It’s valuations like these that draw cash back into the market – and sometimes that cash is in the form of buy outs and go private transactions.

We’ll keep looking for the next Xpel, Hamilton Thorne and Covalon. These unsettled markets are prime opportunities to find fantastic risk/reward scenarios when the upside far outweighs the downside. Stay tuned as we’ll be preparing a list of the nanocap companies that we think have high buyout potential.

To your wealth,

Paul and Brandon

Smallcap Discoveries is a newsletter dedicated to uncovering Canada’s premier emerging growth stocks. Smallcap Discoveries focuses on growing smallcaps with positive cash flow that have gone undiscovered by the broader market. Smallcap Discoveries was created as platform to share actionable ideas and help investors get an edge in the markets. Smallcap Discoveries’ mission is to bring the world the best original research, on-the-ground due diligence, and profitable ideas in the smallcap space. If you’re an avid smallcap investor, Join Us.