The webinar was recorded April 22, 2021.
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find the slides here.
Chris Preston [00:00:05] Hello and welcome to today’s Cabot Wealth Webinar, 3 Micro-Cap Stocks that Could Triple in the next year. I’m your host, Chris Preston, Chief Analyst of the Cabot Wealth Daily Advisory and Vice President of Content here at Cabot Wealth Network. With me today is Rich Howe, chief analyst of our Cabot Micro-Cap Insider advisory. Today, Rich is here to highlight the extreme outperformance of micro-cap stocks for nearly the last hundred years, how to identify the best micro-cap stocks to buy in a sector in which most of the stocks have little to no analyst coverage. And he’ll also give you three micro-cap stock ideas he thinks could triple in the next year. This is an interactive webinar, which means we’ll be fielding your questions after Rich’s presentation concludes. So if you have a question, feel free to ask it at any time. In the question box under the control panel, we will try to get to as many of them as time allows once Rich wraps up. Just keep in mind that we cannot offer advice in regards to your own personal investing situation or portfolio.
Chris Preston [00:01:05] First, let me introduce Rich. Rich is a trained economist and chartered financial analyst who has researched and invested in stocks for over 20 years and become a recognized expert in micro-cap stock investing. He started his career at an investment advisory firm, Eaton Vance, where he covered a wide range of sectors, including software and Internet, financials and health care. Following his time at Eaton Vance, Rich joined the Citi Private Bank Private Equity Research team and led the creation of a private equity and real estate fund, a fund that raised over three hundred million dollars in capital commitments from sophisticated high net worth individuals and institutions. Rich left Citi to launch Stock Spin-Off Investing, a research service focused on tracking and identifying the most promising stocks, spinoffs and special situations. A year ago, he joined the Cabot team and launched his Cabot Micro-cap Insider advisory, which has outperformed the market by a substantial margin which I’ll tell you about just a minute. Bottom line, Rich is one of the few people who truly knows what he’s talking about when it comes to micro-cap stocks and investing in them. So I’ll let him do just that. Rich, take it away.
Rich Howe [00:02:14] Thanks so much, Chris, and thank you, everybody, for joining us today. So, as Chris mentioned, it’s been about a year since I came aboard the Cabot Wealth team. And so it’s a great time to assess performance, take stock of the micro-cap market and then get into some of my best ideas for the next year. So first, many of you might be a little bit new to micro-caps, but micro-caps or penny stocks, there’s no standard definition. But generally, the way that I think about micro-caps is they typically have a market capitalization of two hundred and fifty million dollars or less. Most companies that you’ll look at or you’ll hear quoted on CNBC will have a billion dollar market cap, would be considered a small cap. So we’re talking about companies that just a quarter of a size of the typical of a of a billion dollar company. Some other names that I’m recommending in that I’m talking about will be absolutely tiny. Not all of the names are tiny. But to give you an example, one of the names that I recommended last year was a company which had a two million dollar market cap, not two hundred million dollars, two million dollars and the appealing thing about it was that it had over two million dollars of cash on its balance sheet, no debt. It was a profitable business, generating positive free cash flow and positive earnings. So that’s what you can find in the micro-cap world. And that’s why it’s so interesting and why it’s one of my my biggest passions in terms of investing.
Rich Howe [00:03:46] OK, so let’s step back and talk about the micro-cap market. So I look primarily in the US and Canada and in these two regions there are about ten thousand companies that are public. So there’s a lot to sift through. It’s not like we’re just looking at the S&P five hundred and we’re trying to find the same large cap stock that everybody else is looking to. One of the big reasons why micro-caps are interesting and Chris touched on it earlier is because historically they’ve outperformed. So generally they’ve generated from I think it’s 1935 to 2016 microcaps have generated about an almost an 18 percent compound annual return. That’s enormous. And I’ll compare it to larger stocks in a few slides. But that’s the main reason why micro-caps are so interesting. And then one other just interesting tidbit is that micro-caps have generally have no analyst coverage. So right now I said thirty four percent. That’s defining microcaps loosely. Those are looking at many of the bigger micro-cap companies. Most of the companies and I’m recommending have no analyst coverage whatsoever. And so it just is a nice opportunity because Wall Street hasn’t really uncovered these ideas. And by the time that they get bigger and their valuations expand and sell-side analysts start picking these companies up. We’re happy to sell our micro-caps that we’ve bought at really bargain basement prices to other institutions that are coming in and just starting to recognize the stocks.
Rich Howe [00:05:21] OK, so this is was the data that I wanted to quote before. So micro-cap stocks, as you can see at the bottom, about a 17 and a half percent return, going back almost almost one hundred years, about 90 years. And it’s very it’s a very interesting pattern. The larger the stock, the lower the return. Now, a nine point two percent return every year for the past 90 years or so is very good. And 11 percent even better, 12 percent even better and 17 and a half percent is the best. And at this point, I have a pretty long term investment horizon. I’m in my mid thirties. And so that’s why I think the microcap stocks are the most interesting, because there’s just the most upside potential and because it’s possible to find what I call growth companies that are trading at value prices. So that’s why I think micro-caps are so interesting.
Rich Howe [00:06:12] OK, it’s been about a year since we launched that launched the Micro-Cap Insider, so I wanted to review performance. So this chart is a little bit busy. But essentially, if you look down at the bottom slide, which is highlighted in blue or the bottom bottom row, which is highlighted in blue, you see that sixty six point zero percent. So that’s the average return of all of my recommendations. Remember, I’m coming out with the new recommendation every month. Versus the S&P five hundred, it’s outperformed the S&P five hundred by forty one point five percent in the past year, and it’s outperformed the microcap index by about 19 percent per year. So some very strong performance, which I’m proud of. And I’m glad that Micro-Cap Insiders have been able to take advantage of - but the most important thing is that’s just in the past. Right. And I’m still seeing many really interesting opportunities. That’s the beauty of the micro-cap market, that there are ten thousand names for me to sift through. So there’s never a shortage of ideas. You may notice that there’s a big black box on the slide that is basically blacking out the names of the companies that I’m currently recommending that’s only available for Cabot Micro-cap Insider subscribers.
Rich Howe [00:07:29] OK, so how do you find the best micro-caps? What should you look for? Well, typically the people will tell you that it’s important to look for liquid stocks that you can get in, in, into and out of if you really need to. But what I look for, it’s not so much what I look for, but these are the most interesting opportunities to me. And it just happens to show that these are these statistics just happened to show that these low liquidity stocks tend to be the best performers. So generally and you can see if you’ve invested in low liquidity or liquidity micro-caps, you’ve generated about an 18 percent to 19 percent compounded annual return. So we even better than the average microcap return. So one one thing to to look for another way to interpret this is what should you not invest in in the micro-cap market? So oftentimes you’ll see stocks tripling or quadrupling or going up by a thousand percent in a day or two. And that’s all well and good. But the most important thing that you should look for is the share count outstanding. What I’m looking for is I don’t want too many shares outstanding because if there are a lot of shares outstanding, it shows that that the micro-cap is very liquid and that historically management has issued a lot of stock to fund the operations of the company. We don’t want management issuing stock because that just dilutes us and dilutes our performance going forward. So the big thing to look for when you’re evaluating a micro-cap stock or the first thing that I look for is how many shares outstanding does it have? Is it under 20 million shares, is it under 30 million shares? That’s what I usually look for. If it has over one hundred million shares, sometimes you’ll see companies with a billion shares outstanding. That and if it’s a micro-cap, that is just not a good sign. So usually that’s a good sign to run for the hills.
Rich Howe [00:09:24] OK, what else do I look for? This might seem pretty obvious, but I look for a low valuation. So this chart, basically this data is from O’Shaughnessy Asset Management, which is a very good a very good firm that I follow that really has a lot of good quantitative data. And what they basically said is, if you look at the micro-cap market and you go long the the cheapest names and short the most expensive names, you would generate a twenty eight point two percent annualized return. So some pretty incredible performance. Now, the only problem is it’s really hard to short micro-cap stocks and I really wouldn’t recommend it. There’s just too much risk. Your risk is really unlimited and your downsides unlimited and your upside is capped. So I don’t recommend shorting. But another way to take advantage of this dichotomy is really just to focus on the lowest valuation stocks, the stocks that are the cheapest. The third thing that I really look for is momentum, so momentum is real, so you might think that a low valuation and momentum are two things that don’t belong in the same sentence, right? Value stocks typically don’t have high momentum. In the micro-cap world, you can find micro-cap stocks that have momentum and are cheap and have improving fundamentals. Like I mentioned earlier, it’s possible to find companies that are growing revenue 15, 20 percent per year, yet trading at single digit price to earnings ratios. You just can’t find that in the larger in the larger stocks. So you want to look for companies that have positive momentum. You don’t want a stock chart or a revenue chart that just goes down into the right. That’s usually not a good sign. You usually want to wait for momentum, a little bit of a turn in the business before getting involved in the stock. And again, the data here shows that if you were to buy the high momentum micro-caps and short, the low momentum micro-caps, you would make a twenty four percent annualized return. Again, we don’t recommend shorting stocks and especially micro-caps, but the way that you can take advantage of this factor in the market is by focusing on micro-caps that do have some positive momentum.
Rich Howe [00:11:44] OK, other things that I really look for, one thing that’s really important is high insider ownership. So in the micro-cap world, you really want management to own a significant portion of the company, usually over 10 percent, I’d say at a bare minimum. But oftentimes many of the names that I’m recommending, the management team or the chairman of the board owns 40 to 50 percent of the company. And the reason why that’s so important is because incentives really matter. And if the management team and the chairman of the board is incentivized to get the stock price up because he or she owns many shares, then we can essentially ride their coattails and know that we’re well aligned and that they’re going to be making decisions that they think are in the best interest of the company and will improve their wealth or increase their wealth going forward. Relatively low share count. We already touched on that. So I won’t I won’t rehash that here. But I look for the lower share count, the better and then a reasonably a reasonable balance. So I don’t want companies with a ton of debt. I don’t mind companies with some debt, especially if they have a very stable revenue base. We’re recommending a private equity management company that has a lot of debt. And I oftentimes get some questions on the debt on the balance sheet. But the reason why I’m so comfortable with it is because private equity companies, when they raise funds, they raise capital from investors and those investors that commit funds to to the private equity strategies, commit to paying a fund a fee for 10 years. Right. And the hedge fund world. And in the mutual fund world, your assets under management can disappear in in a year or months or weeks or even sometimes days. But in the in the private equity world, your money is locked up basically for 10 years and you have to pay your fee no matter what. You have a contractual obligation. You could get sued if you don’t pay your fee. And so in instances like that, I’m not too concerned when a company has a decent amount of debt. But that’s something that I really want to look for because it’s very, very important. And things could go badly, very quickly if you have an if you have an over levered company.
Rich Howe [00:14:03] OK, now let’s get into the meat of my presentation, three micro-caps that could triple. OK, the first name that I’m going to talk about is a name that if you are a Cabot Micro-cap Insider, you probably are familiar with because this is a name that has gone up over 200 percent since I initially recommended it last May. But importantly, I think most importantly today, looking forward, this stock could could easily double or triple. I think it could even go up by five times. I don’t it’s hard to predict exactly when these things will happen. And obviously, I can’t guarantee that we’re going to see tremendous capital appreciation with Medexus Pharma. But I have a strong belief and it’s actually my biggest personal holding. This is my largest individual investment. And it’s because I think that this company has the best risk reward outlook and has the most upside of of any name that I’m really seeing across any spectrum. So just to talk about a couple of bullet points, this is a Canadian pharma company. They recently completed an excellent deal and they’re trading at a very attractive valuation. So these are very broad comments. I’m going to dive into each one of these bullet points throughout this presentation.
Rich Howe [00:15:18] OK, so let’s first talk about what Medexus is, so Medexus is a specialty pharma company, and what they really focus on is selling drugs, pharmaceutical drugs and compounds in the United States and Canada, they’re not focused on Europe, they’re not focused on Asia. They’re just focused on the North American continent. And they don’t spend a lot of money on R&D. What their business model is really focused on identifying drugs that will meet unmet medical needs and basically entering into agreements to buy those drugs or to license those drugs from the companies that created those drugs so that Medexus can sell the drugs in Canada and the United States and make a very nice, healthy profit. And so to just talk about some of the drugs that are in their portfolio. So there are two drugs that are on the top line. One is called the Rasuvo and one is called Metoject. Essentially, these are the same drugs. These this is an injectable methotrexate, which is used for a patients with rheumatoid arthritis. And it’s a small niche product that is still doing quite well. So it has about 80 percent market share of the injection market in the US. So growth is in the in the single digits. But in Canada, this product is relatively new and it’s still growing at about 20 percent per year. And it makes up a substantial portion of Medexus’ revenue. So that’s a nice driver of growth going forward. Ixinity, which is in the middle column, is a hemophilia drug, which is a drug that I know extremely well because I know the company that they bought it from about a year ago. This is a drug that is another injectable that is used for patients with hemophilia. And this drug, last we heard, was growing at about 40 percent per year. And importantly, Medexus is undertaking an R&D trial right now to get this drug to be approved in pediatrics. Right now Ixinity can only be marketed to patients that have hemophilia and are on another hemophilia drug that is not working for them. But obviously, it’s a much better proposition to be able to go upstream and to get new patients, new hemophilia patients. And it’s a big market by being able to market this product to younger folks, pediatrics or to pediatric doctors, who will will basically be able to recommend this drug to patients that are 12 years or younger. It’s going to increase the market size by 50 percent for Ixinity. So it’s already growing at about 40 percent, last we heard. And the market’s going to grow by an additional 50 percent once this trial is completed and the drug is approved for pediatrics. Rupall is just a seasonal allergy product that is marketed in Canada, but the bulk of the revenue is Metoject in Canada, Ixinity and Rupall. That’s over fifty two percent of revenue and it’s growing at a very nice clip. Rasuvo in the United States is more mature. It’s just growing single digits but it’s still a nice revenue driver. And if you add up all of the drugs on this page, except for the drug Treosulfan - you just exclude that, management has come up with guidance that they think that these products could generate one hundred and fifty to two hundred million dollars of sales. So compared to the current market cap of Medexus and the enterprise value, that’s a lot of potential. That’s a lot of sales.
Rich Howe [00:19:05] But the story just got a whole lot better recently when Medexus announced that they licensed a drug called Treosulfan. So this is the drug on the right that’s that’s in green and it’s called later stage pipeline. So what exactly is Treosulfan? Treosulfan is a drug that is basically given to to patients that have AML or MDS, which are two different types of blood cancers, to simplify it, before those patients undergo stem cell transplants. And stem cell transplants is one of the standards of care for patients that have these diseases. It results in sometimes a complete remissions of the cancer, sometimes basically all the time significantly improved survival. So basically Treosulfan is given to these patients before they have stem cell transplants because it allows them to to have fewer side effects and to have the stem cell transplant be more effective. So essentially, this is a new drug that’s going to be approved this summer, which is going to replace a current generic drug, which is the standard of care before this drug, this drug Treosulfan is going to be approved. And the generic drug before it went generic did about one hundred and twenty six million dollars of sales. Treosulfan, because it’s a better drug, it would be unethical to not use Treosulfan and use the generic drug, because Treosulfan is such a superior option. Treosulfan will be able to generate at least one hundred and twenty six million dollars of sales. So you add one hundred and twenty six million dollars of sales. You add the two hundred million dollars of sales from the existing pipeline and you have a run way to three hundred over three hundred dollars, three hundred million dollars of sales, but more like the three fifty to four hundred million dollars of sales. That’s the number that the management thinks all these drugs combined could eventually hit. So you have some very nice growth going forward over the next couple of years.
Rich Howe [00:21:13] So how do we think about valuation here, how do we think about earnings power? Well, we already talked about what the existing portfolio and what Treosulfan and can do in terms of revenue. I project that we will see about three hundred and fifty to four hundred million dollars by 2023 or 2024. And that seems like a long time away. But remember, we’re already in 2021, so it’s only two to three years away that they’re going to, they’re going to get to this high sales number. And because the, the company Medexus is not going to have to really invest much in their company infrastructure. They already have their existing sales force. They’re going to hire a few new reps. They’re going to hire a chief medical officer. But other than that, there’s not a lot of spending that Medexus has to do. The company Medexus at scale is going to be extremely profitable. It’s going to generate at least 40 percent EBITDA margins. And so that that works out to at least one hundred and forty million of EBITDA. Next question is, well, that’s EBITDA but what about interest expenses? What about taxes? What about CapEx? Well, the great thing about specialty pharma companies is they don’t have really any CapEx. This isn’t a capital intensive business. And also, I don’t expect the company to really have any debt by the by 2023, 2024, because they’re going to be able to pay down all their debt from the existing cash that’s generated by this business. So assume that they’re probably going to have to pay taxes, whatever you assume. Twenty five percent to 30 percent. This is a business that is going to generate over one hundred million dollars of free cash flow. So actual cash earnings, I estimate by 2023 or 2024. So a lot of earnings power to this to this company.
Rich Howe [00:23:02] So let’s put it all together, and again, this slide is a little bit busy, but essentially what I’ve done and the upper left hand quadrant is calculated, the fully diluted market cap and enterprise value for Medexus. This is as of April 19th. But I get to about two hundred and twenty one million dollars. If you divide that enterprise number by my estimate of 2023 EBITDA, you get to an applied valuation multiple of one point six times EBITDA. That’s extremely cheap. So peers in the space specialty pharma companies trade at about 15 times, 12 to 15 times EBITDA. If you just assume that this company is going to trade at 10 times that EBITDA number, it’s going to work out to one point four billion dollar enterprise value. And then you’ve got to make some adjustments. If you basically add the cash and subtract out subtract out the debt, you get to an implied market cap of about one point four billion dollars, a little bit over one point four billion dollars. If you divide by shares outstanding, you get to a fair value for the Canadian shares which trade under the symbol MDP.V of about forty one dollars. And you get to a fair value of the American version MEDXF of thirty two dollars. Today the stock closed the American version, which is the one that I bought because I live in the United States, is trading at about five dollars and seventy five cents. So I said that this is a stock that could triple again. It’s hard to know exactly when it’s going to happen. I can’t guarantee it’s going to happen. But I think this is a stock that has the potential to go up four or five hundred percent over the next couple of years. And I think once Treosulfan is indeed approved by the FDA this summer, that’s going to be a huge catalyst to get shares moving in the right direction. They’ve appreciated significantly in the past year. They’ve pulled back a little bit. They’re undergoing some some consolidation here. But I think there is dramatic upside ahead. And again, this is my largest personal position. So happy to take any questions on that. I’ll address all the questions at the end. But if you have any questions, feel free to use the chat tool to ask them.
Rich Howe [00:25:14] OK, so Atento is a little bit different, it’s another actually international company, it’s based and its business is generated in Latin America. A lot of its its business is generated in Brazil, and it is basically a business outsourcing company. So what do I mean by that? Well, really, what they do is if you’re a big telecom company or you are a bank, you’re a credit card processor and you get a lot of customer calls, you don’t want to hire all those employees yourself. If you want to hire a company like Atento who specializes in call centers and other services like that. And so that’s the business that Atento really focuses on. The actual call center business is growing okay. It’s you know, it’s still growing, but it’s relatively mature. But I don’t know if you’ve noticed, but a lot of times you go to a website and you’ll see a chat pop up that says, hey, have any questions, chat me and Atento provide services like that. So they have folks that can if you say, yeah, I do have a question, somebody that helps you, even if it’s AT&T or or whoever your wireless provider is, or maybe your bank, your bank credit card company is, they could be outsourcing that chat to Atento or some of Atento’s peers. The reason why I think Atento is really interesting is because it is its business is actually growing on an organic basis and the industry is consolidating. I’ve spent a lot of time on this industry and it’s consolidating and future acquisitions make a lot of sense. And then we have very high insider alignment. So one thing that I noted earlier is that with micro-caps, you need to be on the same side of the table as management or the board of directors or the big shareholders. In this case, we have sophisticated private equity investors who I actually know from my time in the private equity business, who are very good, very savvy investors who own over 60 percent of shares outstanding. The best way for them to realize their investment in Atento is not to do secondaries and sell the shares in the open market. The best way is to sell the company in total. And it makes all the sense in the world because the industry is consolidating and because there are other companies who have a strategic interest in one, Latin America, but also two, in making acquisitions. It’s the stated strategy of Concentrix, which is another company that I follow quite closely.
Rich Howe [00:27:56] OK, so let’s get into more of the details. OK, this chart does not look good. Earlier in the presentation, I said you want to buy companies with positive momentum. So attentive stock chart looks very good. It’s up over one hundred percent in the past year, but its revenue looks really bad. So what’s going on here? Well, revenue has been declining on a reported basis because they report earnings in US dollars, but on a constant currency basis in the Brazilian Real and other currencies in Latin America, they’ve actually been growing sales on a mid to high single digit basis. And so the risk here is that the Brazilian Real continues to weaken versus the dollar and other currencies continue to weaken versus the dollar. So I think that that is a risk that I think you need to be aware of. But I think the valuation right now, the company more than reflects that risk. And to a company that’s going to acquire that would be a potential acquirer of Atento. They don’t really care about currency risk as much because they operate all over the world. And so the currencies, the different currencies act as natural hedges for different parts of their business. So from a strategic perspective, the currency exposure to the Latin American currencies is not a big issue.
Rich Howe [00:29:19] How is Atento in the industry, how is it viewed? Well, this was a really interesting slide by Gartner, which does management consulting and other consulting, and they’ve identified some of the industry leaders. So if you look at the upper right hand side of this chart, you see Alorica, Teleperformance, Concentrix and Atento all in that upper right hand quadrant. So those are the best of the best. Concentrix, which is a company that I talked about, trades at 10 times EBITDA Teleperformance, which is a French company that’s also active in Latin America, trades at 16 times EBITDA. These are reasonable valuations for the type of businesses that Teleperformance and Concentrix have. Atento trades at a much lower valuation than that. And I will get into that a little bit, a little bit later. But it trades at a fraction of the multiple of these larger companies who, oh, by the way, could be strategic acquirers. But the key takeaway from this lot is that Atento is actually a pretty well regarded company. It does a good job. It’s viewed very well, even though the stock is not viewed very well by investors or nobody really cares because it’s so small and illiquid.
Rich Howe [00:30:31] OK, so this gets back to guidance and momentum. So as you can see, the guidance looks good for 2021 and 2022. Management has expanded EBITDA margin significantly from nine percent in 2019 to eleven point four percent in 2020. And they expect margin increases to continue going forward. They also expect mid-single digit revenue growth in constant currency. One other big concern for this company is that they have a good amount of leverage. Three times, three point two times leverage does not seem like that much. But for a company or for a Latin American company, it’s a little bit higher than most investors would appreciate. But over time, they’re going to be paying down that debt and using their cash flow to really pay down debt and to delever. So all the trends, the operating momentum of the business look very strong.
Rich Howe [00:31:28] And here is the summary in a nutshell, so as I already talked about, sophisticated private equity investors own about 62 percent of the company. They’re very motivated to sell because that’s how they’re going to get all their money back in one big fell swoop. The industry is highly fragmented. So acquisitions don’t always make sense. Acquisitions often destroy value. But when acquisitions happen in highly fragmented industries, that’s when they make sense. A company that I mentioned earlier in Concentrix, which I like a lot, one of their stated strategies is to make acquisitions and also to expand in Latin America. They could check two of those bullet points by just acquiring Atento. Atento is trading at about three and a half times EBITDA and a Concentrix is trading at 10 times. So Concentrix could buy Atento at an eight times EBITDA multiple. It would be accretive to Concentrix their earnings growth would go up. They would get more exposure to Latin America, which is what they want, and then they would be able to harvest a lot of synergies. Concentrix has been very good about making acquisitions in the past and achieving synergies, really over exceeding the synergies that they initially set out to capitalize on. And so the one big point, I would say, is that there’s currency depreciation risk, that’s definitely a risk. But I will say that it doesn’t matter as much to a strategic acquirer. So this is a company that trades at about three and a half times EBITDA. It trades at a distress multiple. Even though the company isn’t distressed, they have no significant debt maturities until 2025. They’ve been generating a lot of free cash flow and they’re going to pay down their debt. So if you just assume an acquisition of about eight times 2022 EBITDA, you would get a basically about three hundred percent upside, almost basically a 90 dollar stock price. And so this is a stock. Again, I can’t predict when it’s going to happen, but I think there’s a high probability that the stock is trading many times higher. If it’s if it’s still around in the next couple of years, you could see a situation where tomorrow we wake up and it looks like Atento has been there’s been an announcement that it was going to be acquired for a 50 percent premium. I don’t think the sophisticated private equity investors HPS Investments, Fairlawn and GIC want to necessarily sell the company tomorrow because they want the valuations to improve over time. And so when they go out to a banker to run a process, they’re going to be able to get a very high offer price. But this is an idea that I think has at least two hundred percent upside over the next year or so.
Rich Howe [00:34:16] OK, let’s get into my last recommendation. So this is a name that will be new to you, even if you are Cabot Micro-Cap Insider subscriber. This is a company called FitLife Brands, and they basically specialize in providing protein powders and different supplements and formulas for bodybuilders and folks that are really focused on fitness. So I I’ve tried out some of their fitness supplements. I go to the gym and I like to have protein powder after I do my workout to help with muscle growth and recovery. They also have this BCAA, it’s called, formula, which you’re supposed to drink during the workout to give you more energy. I’ve gotten that from FitLife Brands. I like their products. So this is a company that basically sells these products and is benefiting from secular tailwinds where a lot of people are more and more focused on being healthy and taking supplements and nutrients that will help them perform better, whether it’s lifting or in other athletic endeavors. So this is a company that is has grown incredibly well. The one knock for FitLife is that historically they’ve been very reliant on GNC, which is a retail store that basically declared bankruptcy last year. But despite GNC declaring bankruptcy, FitLife Brands was able to grow revenue for the full year, a year where there was a pandemic and their largest retail basically couldn’t sell their their products in-store. They grew by 12 percent in the fourth quarter. They grew by fifty five percent.
Rich Howe [00:35:53] And again, importantly, there’s high insider alignment. The the chairman of the company, the CEO, owns over 40 percent of shares outstanding. So he has a motivation and an incentive to get the share price up. The stock has performed well, but it’s still trading really cheaply and I don’t own this one, I haven’t recommended it yet, but I think there’s a lot of upside ahead in 2020, the year of the pandemic, EBITDA grew by fifty four percent. Online sales, which is increasingly important for this company, grew 92 percent. Yet it’s still only trading at six point five times EBITDA because it’s a tiny company with a very small market cap. And and as a result, not as many people are interested in it. But remember, a micro-caps are where the real strong performance is. So it’s important to to allocate at least a little bit of your portfolio to micro-caps because that’s where you can get some juice. Insiders, as I already mentioned, own over 40 percent of the company. And there’s a share buyback authorization for 10 percent of the market cap of the company, so the company is actively buying back stock and it’s in the in the open market. If you were to assume that this company trades at a normal multiple that a typical supplement provider would trade at, there would be about two hundred percent upside. But this is a company that’s growing really fast. Right? They grew 12 percent last year. And I think that they’re going to grow even faster this year and their online sales are growing over ninety two percent. They represent over 20 percent of sales for the entire company. So this is a company which has a lot of upside ahead. It’s very illiquid. So if you’re buying the stock, make sure to use limits. You don’t want to just go in with a market order because the stock price could just spike to fulfill your order. But this is a name that I think has significant upside ahead. And I’m going to be doing significant work on it and maybe even recommending it to my Micro-Cap Insider subscribers in the weeks ahead. OK, so with this, I’m going to turn it back to Chris.
Chris Preston [00:37:57] Yeah, thanks, Rich. I’ll give you a minute or two to catch your breath before we start answering some questions. I see we have a few questions rolling in. In the meantime, just a bit of housekeeping. If you like what you’ve heard from Rich so far today and are interested in signing up for his Cabot Micro-Cap Insider advisory, we do have a special half-price introductory offer reserved exclusively for our listeners of today’s webinar. What you get in return is monthly issues featuring new micro-cap investing ideas, which as Rich outlined earlier, outperforming both micro-cap index and the large-cap index as a whole for the last year since its inception, weekly updates with special bulletins about market updates, news and trade alerts. Twenty four seven online access to our exclusive subscriber website and analyst archives and direct private access to Rich for answers to your investing questions. Again, there’s a limited time offer because of the nature of micro-cap investing, Rich’s Micro-Cap Insider can only have so many subscribers. So act now and you will receive that half price offer in your email inbox in the next day or so.
Chris Preston [00:39:17] Now let’s get to your questions. OK, Florence has been waiting patiently. She asked a while back, “Rich, could you please explain what happened to REPH? I think that was one of the positions you closed out of Rich that you mentioned earlier. And what is the future of the company?”
Rich Howe [00:39:39] Yes, so good question. So REPH is the ticker and the company’s called Recro Pharma. And so Recro Pharma focuses on basically being an outsourced manufacturer of pharma drugs. So for instance, Teva doesn’t want to doesn’t want to manufacture all its drugs itself. It doesn’t want to build out specialized manufacturing facilities for all of its drugs. And so what it does is it outsource some of its drug manufacturing to companies like Recro Pharma. And so what happened with Recro Pharma? So this was this is one of my losers was essentially the company issued very poor guidance. So they came out earlier this year and they issued poor guidance. And initially, I didn’t think that this was that big of a deal because historically the management team for this company has been incredibly conservative and they’ve really exceeded expectations pretty dramatically. And so I wasn’t initially concerned. But then again, the company came back, came out with pretty weak results, really missed expectations instead of growing, which I expected them to do, they—sales declined. And not only that, but they thought that—it looked like some of the companies that they were doing research for, not only do they manufacture drugs for companies that have drugs that are already approved, but they also do clinical research and manufacture drugs for startup, biotech companies who are in the midst of of trials with the FDA. And so a lot of these companies were getting crunched by—weren’t getting much funding. And so as a result, they were really trying to cut their costs and shut down certain programs that didn’t look very promising. As a result Recro Pharma lost some business. And then the trifecta, the third part about it was that Recro Pharma had gotten a big boon, a big boost, basically, because one of the drugs that they manufacture for I forget if it’s Novartis or Teva, had benefited from basically one of their competitors, Mylan, being back out of the market. But Mylan came back in the market in 2020 and took share a lot, took back share a lot faster than the management, the management team expected. And so all those reasons are why the stock, the stock basically took a dive and why we closed our recommendation and sold out of it. Going forward, it’s still on my watch list and I think at the right price or maybe not at the right price, but at the right time, Recro Pharma could be a name that I recommend. What I’m looking for is I’m looking for signs of momentum. I talked earlier about how it’s important to look for momentum. So Recro pharma right now is very cheap. We know it’s cheap based on its earnings potential and its revenue growth, but the outlook—but right now, the outlook is a little bit uncertain and they haven’t reported a couple of good quarters in a row to get people excited about the stock. So what I’m really looking for is for positive guidance, positive revenue growth, signs of momentum in the business and then the other thing that I would really love to see is insider buying. Right. We don’t—one of the things we don’t have with Requote Pharma is high insider alignment. The management team does not on much of the stock. And so that is a little bit concerning. If management were to step up or somebody on the board of directors were to step up and buy a bunch of stock, then that would be incredibly bullish for me. But I’m you know, I get all the SEC filings from Recro Pharma. I am watching this one anxiously because I think at the at the right moment, this is going to be a great buy. You know, I think it could be kind of a three hundred, four hundred, five hundred percent gainer. But I just want to wait for that right moment to make sure that we’re getting in at the right time and we’re starting to see signs of some positive momentum.
Chris Preston [00:43:56] OK, question from Peter. Peter asks “Can you speak to,” I guess just elaborate on, “what the difference is between low and high liquidity stocks?”
Rich Howe [00:44:08] Yes. So low. So I should have an exact answer for you. And I don’t. If I can, maybe I can get your email address or if you follow up, if you email me, I will follow up and get you the exact data. But basically or the data that was used in the study that I’m referencing, but with high, high, high volume or liquidity, high liquidity and low liquidity, I think the way that the data I’m recalling, the way that the data was parsed and essentially the stocks that I think it was, the stocks that had the most liquidity were the names with the most volume. So dollar volume of shares traded on a daily basis of micro-cap stocks with under two hundred and fifty million market caps were the ones that performed the worst. And the stocks with low liquidity, the lowest dollar volume, dollar trading volume where the best were the best performing stocks. So if you divide up the trading volume for microcaps into deciles, the lowest decile with the lowest volume, that was the best performing area of the micro-cap market and then the top decile of the category with the most trading volume or liquidity was the worst performing area of the microcap market. But I can follow up with you. If you have any additional questions or want additional clarity, just shoot me an email.
Chris Preston [00:45:39] OK, question from Nick. Nick says, “Micro-cap stocks are generally quite volatile. So what is your recommendation in terms of percentage in one’s investment portfolio and how to minimize risk?”
Rich Howe [00:45:53] Great question. So I like I said, I it all depends on your personal outlook. So I am very comfortable owning a high percentage of stocks. I probably have fifty to seventy five percent of my investment account, whether it’s just my personal account or my retirement account invested in what you would consider micro-cap stocks. I’m just totally, totally comfortable with the risk. I’m not thinking about them, really. As you know, I’m not too worried if I don’t want the stock price to go down. But as long as I have confidence in the the business, the underlying business, I am OK holding through the volatility. But that is just me. So it’s all a personal situation. And as Chris mentioned earlier, we can’t give you exact advice on what is best for you. But I can tell you that your portfolio shouldn’t be 100 percent invested in micro-caps. But I think it’s probably wise to have some exposure to micro-caps. So you could ease into it with maybe a five percent allocation. And if you if you get comfortable with it, maybe pump it up to 10 or 20 percent allocation. But it really depends on your risk profile. So it’s going to really vary from person to person.
Chris Preston [00:47:07] Good question, multipart question from George. George asks, “How many micro-cap or penny stocks does your Cabot Micro-Cap advisory present each month?” Second question, “You assign a relative risk or do you assign a relative risk level for each stock example? Highly speculative. And why why are there so many interesting Canadian penny stocks relative to other nations?”
Rich Howe [00:47:35] So good question. So the first question is how many stocks do I recommend per month? I only recommend one. So the portfolio right now I think has I want to say it has 15 open recommendations. So I recommend a new stock every month. Occasionally there’s a name that I just can’t wait to recommend. So an example would be BBX Capital. So it wasn’t my normal normal cycle to to recommend a new idea. But I it was just it was just a really compelling spin-off. I follow spin-offs very closely and the stock was trading at like a fraction of its cash on its balance sheet, which just doesn’t doesn’t make sense. And there are a lot of dislocations in the market. So that was an example of a time that I recommended two stocks in one month because I just couldn’t wait to recommend this name. I couldn’t wait till the next month because because the stock price could have been 30, 40, 50 percent higher. And but generally, I’m going to recommend one idea per month. In terms of risk ratings—so I don’t recommend I don’t include a risk rating. I guess I would probably consider them all pretty highly speculative, speculative or highly, highly volatile. But that’s a good idea. Maybe I can incorporate that because I think some some of the companies that I’m recommending have no debt or very little debt. And I think obviously the names that I have more debt are going to be more more risky if things go bad. The downside case is just going to be magnified. So that’s that’s a really good, really good question. Maybe I can add that to my to my record, to my service. The last question on Canada, I don’t know. All I all I know is I basically, I’m a I’m a bottom-up investor. And what that means is basically I look for individual securities that look really interesting and really attractive. And I don’t really care where they come from necessarily. I do know that historically, sometimes the emerging markets beat the developed markets. Sometimes Europe beats the US, sometimes the US beats the rest of the world. Sometimes Asia leads the world. But all I know is it varies from year to year. The past year was just a banner year for the United States and I’ve looked at a lot of data. The US stocks look very expensive relative to the emerging markets specifically, but also to Europe and other parts of the world. And so from a macro level, it does look like the US is a little bit on the expensive end. But what I’m really looking for just really interesting bottom up ideas. And it just so happens that Medexus the name that I like the most. I wasn’t screening for Canadian Ideas. A company called Aptevo, that I closely follow because it’s a spin-off, basically announced that they sold a drug to a company called Medexus Pharma. And I thought that Medexus Pharma got a really interesting, really attractive deal because they only paid thirty million upfront for a drug with forty million in sales that was growing forty percent per year. And so I was just, you know, I was disappointed for Aptevo, but I was really excited about this company called Medexus. And so that’s what caused me to dig into it and do basically drop everything and do a ton of work and call the CEO and CFO and try to try to see if there’s anything that I was missing. So but I am I am finding some other Canadian stocks that are that are pretty interesting. I think it’s just, you know, it’s just as simple as maybe maybe in micro-caps tend to be ignored all over the world. But in the US, maybe, you know, maybe some of them are a little bit more closely followed than others. But in Canada, I’ve just I just so happened to find a couple of really attractive ideas, two names right now in my open recommendation list are from Canada. And then the most recent name that I talked about, Atento, is a US listed name, but it’s businesses primarily in Latin America. But good questions.
Chris Preston [00:51:31] Yeah, I think we have time for one or two more questions and Rich do you mind advancing to the next slide.
Rich Howe [00:51:37] Oh, no, of course.
Chris Preston [00:51:39] OK, question from Philip. Philip asks, “What are your thoughts on the wide spread between bid and ask on micro-caps? I shoot for the middle with a limit order. Does that makes sense?”
Rich Howe [00:51:52] Yeah, that definitely does make sense. So I guess it depends. So it depends on the volatility of a stock. So, for instance, FitLife Brands, which is a name that I recommended today, is incredibly illiquid. So the stock might be up because we talked about it today and and even if, like three hundred shares traded, like the stock will go up. So it’s that’s a really illiquid name. It’s partly because the CEO owns so many shares. But, yeah, I think a really good approach is to is to basically be right in the middle and to be patient. I mean, sometimes the names that I’m recommending pop significantly right away. And usually I don’t recommend that you chase them. I what I do is I give a limit order. So, for instance, for Medxus, my limit order is to buy under eight dollars and for a while, Medexus was bumping up against that limit. And so you do want to be patient. You do want to use limit orders in micro-caps. But at the same time, if you think there’s one hundred percent or two hundred percent upside, it might it might make sense to to basically go a little bit higher than than the middle of the bid asks spread because you’re confident the story, you just want to get your allocation filled before the stock gaps up. What I don’t recommend and it sounds like, you know this, is that you don’t want to just do a limit order. That’s that’s because literally the stock price can jump 50 percent. Just just if you if you enter a limit order, because there might not be that the number of sellers on the market to fulfill your order, but use that limit if it’s a stock that you think is really attractive with one hundred percent plus upside and you think there’s a lot of interest in the market, you can get a little bit more aggressive. But generally, putting your limit order between the bid ask spread is a good way to is a good way to do it.
Chris Preston [00:53:55] OK, I’ll give you the last question to Max. Max asks, “With little analyst coverage, how much institutional ownership can there be with this class of stocks? Without institutional interests what would drive micro-cap prices higher at a greater rate than higher cap stocks?”
Rich Howe [00:54:13] Yeah, so it’s a great question. So the whole idea basically is that you want to own the stocks. The whole idea with micro-cap stocks is to own the stocks before the big institutions come in. So Medexus is a perfect example. I would say retail ownership of Medexus is about 50 percent right now and there are institutions that own a good chunk of Medexus, but it’s only about one hundred and twenty million market cap stock. But as revenue right now is going to go from about one hundred million dollars to four hundred million dollars, Medexus is they’re going to do a dual listing. So they’re going to get listed on the Nasdaq very shortly, I think even maybe by the end of the month. And so that’s just going to increase exposure to US investors. So any any U.S. investor that pulls up a screen of pharma companies that are growing revenue over 20 percent, trading below five times sales is going to be able to find Medexus. Whereas previously they they wouldn’t be able to do that. So as the word gets out that companies like Medexus are growing bigger and bigger, those companies are going to get on more screens or it is going to spread more and more. And then eventually, basically, that’s your liquidity where the institutions come in. Everybody gets overexcited about these stocks. They get bid up really high and that’s when we when we run for the exits. So the whole idea is you want to you want to buy stocks that eventually can be interesting for institutions. You don’t want to buy a company that just never going to be never going to graduate from from a micro-cap to maybe a small-cap and then hopefully a mid-cap and hopefully a large-cap. But the idea is to get in ahead of that transition. And the big idea is really to buy companies that are growing, companies like Medexus that are growing very quickly. I’ll give you another example. A company that I like a lot that I’m recommending is called Liberated Syndication. This is an illiquid podcast hosting company. So I don’t know if you listen to podcasts, I listen to a bunch. I love them. It’s an industry in secular growth growing twenty twenty five percent per year. This is the market leader in hosting. They’ve made a bunch of really interesting acquisitions recently. They’re going to be up listing to the Nasdaq at some point. Right. And so Spotify and other companies are are spending all this money to basically acquire other podcasting companies and then eventually institutional investors are going to wake up and say, wait, I can buy this podcast hosting company that’s trading on the Nasdaq, used to be over the counter, but because it’s gotten so big and it’s so profitable, it’s now trading on the Nasdaq. And I can buy it and I can get growth to this—I can get exposure to this to this secularly growing company and industry. So the key I mean, you don’t want to buy just down and out, you know, crappy, crappy stocks. But the beauty of the micro-cap market is you can actually buy growth companies, but at value prices. So that’s that’s the thing that I love the most about micro-caps.
Chris Preston [00:57:21] All right. That’s a good one to end on. And thanks, everyone, for really good questions today. Thank you, Rich, and appreciate everyone joining us today. We’ll be back next month on Thursday, May 20th, with our next webinar titled Three Power Stocks to Buy now. It’s about power trends that are powering the stock market not only in the US, but globally. And that’s hosted by Carl Delfeld, chief analyst of our Cabot Explorer advisory. So come back next month for that presentation. Again, that’ll be Thursday, May 20th, at 2:00 Eastern. That does it for us, for Rich Howe and the entire Cabot Wealth Network team. I’m Chris Preston and we’ll see you next time.