Great Business On Sale

Nov 19, 2024

Once in a while, the market presents us with opportunities that seem too good to be true. What seems like an outstanding business trades for a cheap valuation, and the setup looks fantastic.

In these situations, I often ask myself: Why does this opportunity exist? Why would a great business be on sale?

Such bargains don’t happen often, and when they do, there’s usually something wrong. Or at least there must be something that appears wrong to most investors, which allows you to make a contrarian decision.

And then, there’s the odd case when nothing is wrong. In microcaps, stocks can get heavily discounted for reasons that are weakly related or unrelated to fundamentals.

Below are a few real examples of opportunities I have found and invested in. Stocks get discounted for lots of reasons, and these are some of my favourite setups:

Forced selling: The company’s founder retires and relentlessly sells his significant position in the market to enjoy his wealth. When he’s done, no sellers are left, and the stock aggressively bounces back.
Turnaround: A new management team joins a struggling business. They cut expenses and spend zero time on investor relations. They just put their head down and work on improving the fundamentals for years. They turn a bad business into a great one without anybody noticing, and it remains underpriced until people find it.
Overhyped IPO: A company goes public at a massive valuation. Everybody’s expectations are sky-high. Fundamentally, the company does well but falls short of the inflated expectations. Maybe they grew 25% a year when the market expected 60%. People get angry and sell. What was once a smallcap becomes an orphaned microcap… until it gets rediscovered by microcap investors.
Controlling shareholder: A foreign entity owns a majority position in a stock and exercises significant control over it. The situation makes most investors uneasy. One day, the company announces a massive share buyback of all the shares from the foreign entity and removes the overhang.
Depressed short-term results: A company’s management team is playing the long game. They make a few acquisitions and take their time to integrate them properly, leading to reduced profitability for a couple of quarters. They exit some unprofitable business lines, leading to temporary revenue declines. Everybody writes the company off. Ultimately, these were the right decisions. The bottom line improves dramatically the following year and the stock recovers (and then some).
Perceived financing risk: A company could be profitable if it wanted to, but it chooses to reinvest in sales and marketing to gain scale. One day, it reaches enough scale to turn a profit. The market’s perception suddenly shifts, and the stock is rewarded with a premium valuation. This example is typical of SaaS companies.
Overlooked quality: Investors haven’t spent the time to dig and think deeply about a company’s moat. The company keeps beating expectations. It is perpetually underestimated and underpriced.

Suppose I can’t clearly identify a reason for the perceived mispricing. In that case, that usually means I have not done enough work. I’m buying something without knowing why the other side is selling, and that’s typically not very smart.

I always ensure I know where my thesis or opinion differs from the consensus. And the more unrelated the explanation is to the fundamentals of the business, the more excited I get!

You only need to find a few of those setups every year. It requires a lot of work, but developing that kind of thesis is so rewarding when it plays out as expected.

The key is being patient and turning over tons of rocks!

What’s your favourite setup?

Disclaimer

This publication is for informational purposes only. Nothing produced under the Stocks & Stones brand should be construed as investment advice or recommendations. Mathieu Martin, the author, is employed as a Portfolio Manager with Rivemont Investments. This publication only represents Mathieu Martin’s own opinions and not those of Rivemont. Always do your own research and consult a professional before making investment decisions.

If you’d like to invest in small public companies, check out this post.