I don’t have any longer form content on my mind this week. I thought I would share a few bite-sized thoughts that have been swirling around in my head:
Small share counts
I have read and heard several discussions of companies with low share counts. I usually invest in tiny companies, so this is a popular idea. I won’t rehash the whole argument, but here are the advantages of a low share count:
Management treats shares “like gold” and doesn’t issue shares lightly. Implies good management discipline in treating shareholders like owners.
Management thinks about per-share metrics. As outside minority shareholders, our benefits accrue to us based on the per-share metrics of the company: earnings per share (EPS), revenue per share, etc. Issuing more shares dilutes the company results for previous shareholders.
Earning per share leverage. A smaller share count implies that EPS is higher than with a larger share count. This leads to a higher stock price. Institutional investors are often limited to stocks that trade above an arbitrary price like $5 or $10.
I believe these things are also true, and I often look for companies with low share counts. Looking for low and stable share counts is a good indicator. It helps avoid a couple of problematic situations:
Investing in marginal companies: These are businesses that are only semi-viable. They totter along and can’t produce enough cash to maintain, much less grow the business. They need to constantly issue shares to stay afloat.
Self-serving management: Companies constantly issue shares to executives who quickly sell into the open market. This is just egregious compensation in disguise. It is often accompanied by constant reports of “adjusted” metrics that back out stock-based compensation from results.
I think it’s interesting to think about the counterfactual as well. Having been involved with some companies that have issued shares over time, there is more nuance here than first meets the eye. First of all, share issuance in itself is not “bad.” Often it is necessary; after all, being public is a way to ensure you have access to capital when needed. I frequently say that “everything everywhere is situational.”
I think there is another area where the share count grows: perpetual turnarounds. In retrospect, people often look at them and claim they are serial diluters or insensitive to outside shareholders. They are like that one mall location that turns over the store every year because there is not quite enough foot traffic to make it viable. These businesses seem promising. Often a change in management preceded a new strategy. Articulating a promising vision, they raise interest in the company. Of course, the new vision requires more capital to fund and requires more shares to be issued. This type of thing is much more common amongst small companies. There are many more companies that inadvertently raise their share counts through well-intended actions than the nefarious types listed above. Management continues to try to right the ship, but they underestimate the challenge and capital required.
I don’t have any grand conclusions as a result, this is just something I have been noodling over.
Think about what you buy in a drawdown
There has been a lot of recession talk lately. The reason that people fear recession so much is that they usually coincide with significant market drawdowns. I don’t know if we will have a recession; if we do, I don’t know how the market will react. This talk has gotten me thinking about buying in down markets.
I have experienced a handful of >20% drawdowns as an active investor. If you have cash, it can be an exciting time to buy. I wrote about this last time. During drawdowns, my propensity has been to buy in one of two buckets:
Companies that have gotten extremely cheap. Companies are trading for less than net cash (net-nets) or extremely low normalized PE ratios.
Good or great companies that have gotten somewhat cheap.
You will probably make money in both buckets. You may make MORE money in the short term in the first bucket. I have tried to split my buys in the past: buy some cheap stuff and some better companies that should do well after the market event.
Companies in group #1 can provide an incredible short-term return. Often 100-200% in just a year or less. The problem I have found is that the market event is over by the time these returns are realized. Now you are stuck with cash to redeploy. You can put it into the good companies at higher prices. That always felt a bit short-sighted to me. Ideally, you would roll it into something cheap again, but the market may have moved on, and those bargains might not exist. Granted, it’s a high-quality problem to have.
Conversely, group #2 may not pack the same short-term punch. However, the companies may well be positioned for good long-term growth, and the compounding may continue at a solid but less frenetic pace in a normal market. Oddly, I can remember very few of the types of investments I have made in group #1. Group #2 investments stick in my mind. A few of the companies in my portfolio fit into that category.
Again, I don’t have a great insight or conclusions. This is just a topic I have been thinking over for a bit, and I thought I’d share. I’m curious if anyone else has any great strategies they deployed for dealing with this. Feel free to drop a note in the comment section if you do!