A Penchant for Pain: A Search for Big Returns in Small Packages

The research in this newsletter is not designed for those looking to feel comfortable in large crowds. Our ranking tools and model portfolios pay various levels of respect to the momentum anomaly. “Momentum anomaly” is merely an academically vetted term for performance chasing.

And make no mistake; we have some very clever sub-components in our momentum loadings that look like they came out of a high-speed quant shop. We get the game. But aside from our high-speed trading model – a rarity for KCR – our product suite overwhelmingly favors fundamentals.

In the 14 years of research that underpins the various products in our offering, this penchant for “prime rib trading at hamburger prices” has served us quite well. The exceptions are 2018-2020 and, to a lesser degree, 2023. 2018-2020 made the dot.com bubble look like child’s play, and our penchant for mispriced profits brought agony and moments of existential uncertainty.

We feel fortunate to have survived the sheer madness. KCR is deeply grateful to every individual and firm that stuck with us through those dark years. Thank you all.

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The good news is that the echo bubble of 2023 has once again created fantastic price distortions. KCR has a long history of highlighting what is going wrong in our product suite. And for good reason: buying mispriced fundamental value over longer horizons is a superb way to preserve and grow capital.

Our most recent example of this was highlighting our Large Cap Model Portfolio in November 2023. At the time, the model was suffering its second-worst drawdown relative to the benchmark in its history. In that moment it was our worst performing product. Tacking into the pain on that model has paid off.

We write this piece in that spirit of transparency and a willingness to highlight our worst. A longtime client and avid user of our Microcap Model Portfolio gently noted that we were, ahem, losing to the Russell 2000 benchmark (“R2000”). By a lot. The chart below shows how KCR’s Micro Model Portfolio has produced a “push” vs. the Micro benchmark but has lost to the R2000 by -10% (+13% vs. R2 up +23%).

Our Micro Model Portfolio is designed to beat both the Micro bench and the R2000. It provides Microcap mandates with a systematic edge and gives R2000 managers some exciting, smaller, off-bench names to work on. Since its official inception in January of 2011, KCR’s Micro Model Portfolio has delivered incredible results.

Over the next month we will detail the extraordinary opportunities in the market’s true small caps. The quality and value features KCR is surfacing in the less than $1bn market cap range border on the comical. Even during the dot.com bubble when most of the KCR team was working, we cannot recall having to do less work to find more interesting companies than we do today in our Microcap Model.

But something funny happened. Everything KCR does is evidence-based, process-driven, and designed to systematically exploit the abundant behavioral errors that drive rampant market inefficiencies. But at our core we are still stock junkies.

We made a fatal error as the team began to dutifully build out the chart stack to explain the systematic anomalies our Microcap Model was bringing into focus.

We looked at the most recent list of top-ranked stocks.

First, we saw some familiar old stocks trading at inexplicably low valuations. With our interest sharpened, we could not help but take a quick look at some of the newer names we had never heard of. And then it happened: we started printing 10-Ks.

And that is how we find ourselves here. We have had some of our senior researchers write up brief and blunt bullish notes on stocks old and new. In total there are three.

Two of these brief notes will come to you next Friday. Today, we offer you a list of the top 50 ranked stocks in our Microcap engine, which is shown in the Exhibit below. And if you click on this link it will bring you to a stock with the following characteristics:

1. A stock trading below an all-cash bid that the board of directors has not responded to and….
2. The market has not noticed because precisely zero analysts cover it
3. The company’s unique set of assets benefit from regulatory moats that have suddenly…
4. Sent demand for the company’s services soaring and created significant increases in pricing…
5. And the stock is, in many ways, a hedge against both geopolitical instability and inflation, yet,
6. The firm’s contracts give it significant visibility into future revenues and profits, meaning…
7. Even if none of the good news above is recognized, its prodigious cash flows are available to repurchase shares which makes sense because…

The stock is so cheap that even a single point increase in its multiple would send it up 50%.

We admit, it is a small stock. Hence the name “Microcap Model.” At the very least, you hopefully enjoy the read, and at best, do your own work on this and other names and find what we seek: big returns in small packages!