This is the question most prospective investors of our managed funds and anyone interested in small cap investing ask us. Identifying investment ideas, whether it is ASX listed companies or global companies can come about many ways. It could be we stumble upon them by trawling through all the companies on an exchange or through screening or even observing the holdings of other like-minded small cap value funds. (VIEW LINK)
Our first port of call is to search for investment ideas using company screens. This is usually through Bloomberg or Capital IQ financial platforms. These platforms allow us to identify a shortlist of companies by setting limits around market capitalisation, countries, industry sectors, profitability metrics such as return on equity, valuation metrics such as price-to-earnings ratios and financial health metrics such as gearings ratios.
Some of our standard screens for our domestic managed funds include ‘ASX High Yield’ which is looking for high dividend yielding small cap companies and ‘ASX Value Microcap’ which looks for cheap growth stocks. We also have individual screens for specific industries or specific geographies.
Screens are useful in that they help you come up with a focused shortlist of investment ideas for deeper research. The biggest downside I feel is that often the best investment ideas don’t screen well. There are certain nuances with companies that don’t screen well which makes them a highly prospective investments.
Trawling through the entire stock exchange
A great exercise I recommend to all investors is to trawl through the entire company list of a stock exchange. This overcomes some of the shortcomings of using a screening tool. From a list of all the companies, I remove all those above $500m market cap (as we are focused on microcap and small cap companies) and remove listed investment companies, REITs, energy, mining and biotech companies. From there I have a look at each one’s financials, focusing on the income statement and cash flow statement and a description of what the business actually does. I find this exercise, repeated a couple of times a year, give me a good understanding of a particular market very quickly, even if it only yields a few investment ideas.
Following like-minded fund managers
I also say to our team, that it’s not where the idea companies from that matters; as long as you do your own research and come to your own conclusions. I often trawl through fund manager’s monthly or quarterly letters, investment forums, blogs and websites such as ValueX Vail.
Meeting with company management
Each year with meet with a couple of hundred of companies whether it is at broker presentations or one on one with the company’s management teams. Most of time we are meeting with companies that we are not already invested in, to gain a better idea of how their business works, certain nuances in their business that is beyond the annual report and to understand what changes are happening inside their business and their industry overall. Sometimes we learn about how competitors are performing and this provides another great source of investment ideas.
Finding global companies in the same industries
A couple of our best investment ideas for our Global Microcap Fund, in the online travel sector has come about from our experience and understanding of the online travel players listed in Australia, primarily as a result of our investment in Webjet Ltd (ASX: WEB) and previously in Wotif (ASX: WTF). Our understanding of the market globally in the online travel industry, the value chain in the industry and competitive dynamics allowed us to identify two online travel companies, one in the UK and one in continental Europe.
Everyone has a different way in identifying investment ideas. As long as the process provides a constant stream of ideas for further research, stick with it and always look for ways to improve it.
Written by Shuo Yang - Microequities Senior Investment Analyst