Back to School; Conversations with Ryan Modesto, Aaron Dunn, and Paul Andreola



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I don’t know about you, but this is my favourite time of year; autumn. Summer’s over and it’s back to “school”. The change in weather brings cooler days/nights, and that means more time inside. In the autumn, I read more, and thus learn more, with a warm cup of coffee, latte, or tea by my side, whether that be at home or at my local Starbucks.

Now, I wasn’t a particularly good student through my school years; my teachers would often tell me that I was inconsistent, and didn’t pay attention in class or to detail on assignments. But that’s because I was more interested in other things, and not what was mostly taught in science, math, or english class. And while other kids were completely immersed in the world of Harry Potter, pouring over every book in the series, I was on the internet, and in the local library, researching Warren Buffett, and the world of business/investing, as well as conceiving every which way to make money at a young age. Now that I’m older, I definitely agree with Mark Twain when he said, “I never let my schooling interfere with my education”.

So, I’d like to kick off the season with a special 3-in-1 issue. I asked Ryan Modesto (5i Research), Aaron Dunn (KeyStone Financial) and Paul Andreola (Small Cap Discoveries), to educate us about their journeys into the investment world (i.e., their “education”), including their thought processes, as well as provide some exclusive, and tailored content for you all. Ryan – insights on 25 Canadian small-cap stocks (sourced from members of the Capital Compounders Club), Aaron – thoughts on when to sell a stock (and when to buy more). Paul – explanation of “reverse engineering the perfect stock”. I know all three guys; they’re great people, and experienced investors. Our stock picks have some overlaps because we approach the markets, and construct our portfolios with a similar framework; leaving no rock un-turned to find growth stocks in the micro-cap, small-call, and mid-cap space.

Hopefully, all of this content will build on what you already know and help you become better investors. “The more you learn, the more you earn” as they say. I even encourage you to email Ryan, Aaron, and Paul if you have any questions or comments based on what you read. I’ve included their email addresses in each respective section below.

(By the way, Aaron Dunn and Ryan Modesto are both presenting at the Toronto Money Show this weekend; Sept 8/9. And I’ll be attending on Sept 9th. Let me know if you’re going too…)

Ryan Modesto (5i Research), 

At a young age, I was always interested in the concept of money: What is, how it worked, and how the value of something was determined. It first manifested itself through the discovery that I could loan out my personal savings from my piggy bank to my older siblings and magically make more money off of what I already had. Seeing dividend cheques to family members in the mail and the concept of owning a business and making money while doing ‘nothing’ immediately grabbed my attention and encouraged me to learn more about businesses, how they operate and how they make money.

It was this interest in how money and businesses work that led to my affinity for fundamental investing. Out of interest over any conscious choice, I would always find myself looking into companies: How do they operate, what’s their strategy, what do they do better, and how do they make a profit on a particular good or service. Naturally, this progressed into gaining an education in business/finance and eventually working in the field of high net worth portfolio management while investing for myself all the while.

When first starting out investing, I quickly realized that where someone could truly add value was in the less followed small to mid-cap space. In my opinion, most individuals don’t need a professional to tell them that BCE Inc., Bank of Nova Scotia or Enbridge will likely make good investments. It is the smaller names with less coverage where the help is needed (and is the niche we try to fill at 5i Research) and where great opportunities can be found. This is especially the case in Canada where many great Canadian companies operate outside of energy and metals but simply do not get the time of day from the broader investment community.

As is probably apparent, I take a bottom-up fundamental approach to investing with a focus on small to mid-cap names. Typically I will not bother with companies below a $100 million market-cap as this acts as a low-bar type of filter. If a company is really on to something and goes from a $50 million market-cap to $100 million, chances are that the growth potential will still exist and it is also significantly de-risked in terms of proving out the business model and that there is a demand for the goods and services the company provides.

Fundamentally, I try not to limit the metrics we look at but if we were to focus on a few metrics, it would likely be:

•    Revenue growth expectations
•    Strong balance sheet (debt load, cash, financial flexibility)
•    Insider ownership
•    Return on Equity
•    Past growth trends of top and bottom lines
•    Attractive margins relative to the industry
•    Qualitative factors – Company strategy, competitive advantage, shareholder friendly (no dilution, dividend raises, share buybacks, etc.)
•    Valuation relative to growth and peers

As far as the process goes, I run various stock screens that filter out companies that rank well on metrics we are looking for. This helps with idea generation. I also like to look at 52-week highs to find companies for adding to a watch list. Otherwise, the process involves reading as much as possible for new ideas and then diving into the fundamentals when an idea piques my interest. Whether it is news items, quarterly reports, management commentary or signals (such as ZCL composites signaling investors), I try to take in as much as possible within time constraints to help find the best possible opportunities, some of which are included in the list below.

Ryan’s Insights on 25 Canadian Small Caps (sourced from members of the Capital Compounders Club) – 

Covalon Technologies

A bit small for our tastes but revenue has more than doubled in the last two quarters and it looks interesting for a higher risk investor. Except for 2014, the company has ad negative operating cash flows all the way back to 2002 and it is low on cash so it may be due for a financing sooner than later. Insiders own a large amount of shares.


Insiders own over 50% of shares. The recent quarter was strong with revenue up 32.3% to $24.1 million and they gained an additional contract for Shine and Ripe, which is a key area to watch. At 13 times’ next years earning expectations, IFX is worth a closer look.


This is a company that has been a bit of a wild ride for investors. Revenues are expected to grow at 16% for the next three years but the valuation is taking a lot of that growth into consideration it seems already, with shares trading at nearly 5 times sales. The balance sheet is strong, however. It is not a company that ranks too high on our list, but does have potential.

Terravest Capital

With 69% of revenues coming out of Canada and a focus on the energy sector, it is difficult to be overly excited about TVK. Debt has been growing while cash flows are a shadow of what they were compared to the last two years.


Investors that want to gain exposure to the e-commerce trend could be well served by a company like Cargojet. Our main issue with CJT is that it is on the expensive side with only mid-single digit growth and a lot of debt. So if the economy hits a bump, names like CJT could see a lot of volatility.

Pure Multi Family REIT

RUF is doing well and we like the US exposure, which offers a bit of a stronger economy for investors. With the recent sad events in Texas and the allocation this company has to the geography, an investor may want to wait a little here in case there are some damages that occur.

Lite Access Technologies

Between a $50 million market-cap, negative momentum and the company hitting new lows, we would see little reason to own a name like this at this stage.

Savaria Corporation

We have covered SIS since it was just $5.16 and are very happy with the returns. But we think the company is just getting started. The recent purchase of Span-America has good synergy potential and strong tailwinds (aging demographics) should support the company longer-term. We have recently updated our report on SIS which can be accessed through a free trial.


This is another name that we have covered since it was at $7.40 and operates as EasyHome. The company has been seeing a lot of success in the small personal loan space and is growing its customer base at a good rate while having a cheap valuation and good dividend. It is economically sensitive, so there is more risk in a name like this inherently, but we like what we are seeing here.

Nemaska Lithium

We like the lithium space in general, so as a proxy to demand for lithium, we think Nemaska is interesting. While it is speculative, we think it can have a place in a high-risk investors portfolio.

Pioneering Technology

This is a name we recently added to our growth model portfolio. While small, PTE posts solid margins and is profitable already. Insiders own a good chunk of shares, the balance sheet is strong and not a whole lot of debt is on the balance sheet. Revenue has grown at a rate of 25% annually over the last five years and 50% over the last two years.

Redishred Capital

At a $32 million market-cap and some very volatile trading, it is hard to like KUT too much at this stage and it is a name we would give time.

Ten Peaks Coffee

We have included our recent report update on TPK as a bonus to readers. TPK is a name we want to like, but with such a long lead time until their expansion is underway and risks that exist as the build out progresses, it is a name we think an investor can come back to in a year or two.

Bellatrix Exploration

Between the high debt and share consolidation coupled with a weak energy market, we find it hard to like BXE.

Intrinsyc Technologies

ITC is an interesting name that could see some growth through the Internet of Things trend. They are getting contracts and growing the top line. This is a company that will see volatile results quarter to quarter as they still rely on relatively large single contracts that can skew results any given quarter. The key is to look at the longer-term trends in results. They also have a sizable contract that could be signed in the near-term as a catalyst.


Good ROE, high insider ownership, strong balance sheet. Its still a bit small for our tastes and while growth is good, it is from a small base. Could be a name to watch but a little too soon in our view.

Diversified Royalty

Up 11.8% as we write this due to the purchase of Air Miles Trademarks. DIV paid $53.75 million for the trademarks and DIV is looking much better after this deal. It raises DIV’s revenue by $8.5M and increases distributable cash per share by 50%. The dividend is being maintained, but the dividend payout ratio drops from above 150% to 107% and should drop under 100% with time.

Symbility Solutions

With SY trading at above a $100 million market-cap, we think it is getting interesting. Management expects $40 million in revenue this year. Context is helpful here though: SY has been around for some time now and the share price is only up 45% since 2001 or 2.8% per year, not exactly a great investment relative to the volatility and not one of our favourite names.

Avante Logixx

A lot of the growth is coming from past acquisitions but not much of this flowing to the bottom lines in the form of higher EPS. The company did note there could be an acquisition by them on the way which could act as a short-term catalyst but overall XX is a company that ranks lower on the list for us.

Siyata Mobile

Our issue with Siyata is getting our heads around the business potential. They are getting attention and making some good moves but at the end of the day we are not confident yet in the size of the market potential and the differentiation of the offering that exists. We would give this name a few quarters before considering a position.

ZCL Composites

We like ZCL. They have been a solid capital allocator, have been increasing dividends materially and buying back shares. So management is trying to get investors’ attention. Add in a decent dividend yield and fair-to-cheap valuation and we think ZCL is a solid name.

Automotive Property REIT

This company comes down to the distribution and how sustainable it is. Based on cash flows, the distribution is more or less 100% which is ok given the business model but does not leave a whole lot of wiggle room. A bit more cash n the balance sheet to act as a cushion would probably make us more comfortable here. For high risk but outsized income, we think APR looks ok.

Highliner Foods

HLF is getting quite interesting from a value investors point of view. We are not fans of the negative momentum but with a 5% yield and trading at 9 times earnings, HLF is likely getting a little oversold at this stage. The company likely fell asleep at the wheel a little with the weakness in breaded products but we think it could be a name to average into over time.


We like Freshii but the investment case here comes down to valuation. On a one and two year outlook, the shares are quite expensive, but if the company can deliver on the growth potential, we think it will do well over the long-term. If you can think 3-5 years out on this name and ignore the volatility, we think an investor will do well. The franchises can be cheap to open and fit both small and large formats and they ‘feed’ into the healthy eating trends in North America.

CVR Medical Corp

Between being down 40% in the last year and below a $20 million market-cap, this company will need to do a lot to get back into investor favour and we would give this name time before getting involved.

Aaron Dunn (KeyStone Financial),

My journey into the stock market began, believe it or not, with reading a book. The book was The Intelligent Investor by Benjamin Graham who also happens to a key mentor of the famous Warren Buffett. Like the rest of the world, I knew who Warren Buffett was; or at least I was familiar with his reputation well enough that I knew it was worth listening to the people who mentored him. I didn’t know much about the inner workings of the stock market at the time. What I did know was that it is a critical part of our economic infrastructure and a place where capital could be grown or destroyed.  How to pick winning stocks in a practical sense was a mystery to me. Armed with the confidence of having recently completed several courses in finance, economics and accounting in my business program, I was determined to unravel this mystery. Warren Buffet once said that everyone should read this book so I knew it would be a good place to start.

A pivotal moment came for me when reading a section titled Business Valuations versus Stock-Market Valuations in Chapter 8. In this small section, Benjamin Graham laid forth the concepts of differentiating between price and value, how a company and its stock chart were not the same thing, and how focusing on share price movements over fundamentals was inhibiting investor performance.  That one section rang clear with me and opened my eyes to what investing and the financial markets really were and what they could become. In its best form, I saw symbiotic relationship between individual people that needed to grow their savings and companies that needed capital to expand their businesses; creating jobs and powering economic growth. I saw a mechanism for individual investors to profit directly from the hard work, innovation and ingenuity of talented business people and gain exposure to growing industries and niche markets that would otherwise be unavailable to them.

The reality of the stock market is not this simple. But I believe that fear and mistrust of the financial markets stem mostly from a lack of understanding. When armed with tools to understand investing and make informed decisions, people are able to avoid the situations that get them into trouble…unscrupulous advisors and promotors and speculative or highly complicated investments.  I knew very quickly that my path was to help guide people on their journey through stock market and to the end destination of achieving their financial goals.

Aaron’s Thoughts on Making the “Sell Decision” – 

In my experience, investors fret far more over making the decision to SELL than they do to BUY. Selling elicits powerful emotional triggers. Selling after a huge return allows you to lock in profit but there is the fear of missing out if the share price keeps rising.  Selling after a big decline allows you to avoid further losses but eliminates the opportunity of any future recovery. These are the decisions that cause many investors a great deal of stress. The fear of lost opportunities balanced with the fear of losing existing capital. Making the wrong decision can cause an emotional sting that stays with you for many months or even many years.

The way to approach the SELL decision is to remove the emotion from the equation. At one point you made the decision to BUY the stock and you need to return to those initial reasons. Those reasons should have been based on an informed analysis of the financial characteristics of the company, the market in which the company operates and the share price valuation relative to the underlying profitability (don’t overpay for assets). What’s changed since you bought the company? Have positive earnings turned into net losses? Has growth slowed or the outlook deteriorated? Has the management team made promises on which they haven’t been able to deliver? Has the company become significantly more expensive on a price-to-earnings or price-to-cash flow basis? Every situation is different but these are the types of questions you need to ask yourself.  Not liking the answers is an indication that it is likely time to SELL.

At KeyStone, we’ve made many hundreds of BUY and SELL decisions over our 17 year history. Within these individual scenarios there is a clear pattern that can be applied to any stock investment. Below I’ve provided 4 individual, real life examples of when we were faced with the decision to BUY, SELL, or HOLD and the process we used to provide value to our clients.

Case Study 1: Share Price Down – SELL Now!

An abrupt drop in a company’s stock price can cause fear and panic. For many value investors, a lower share price marks a potential opportunity but in many cases the market is correctly revaluing a company based on a change in financial characteristics.

Grenville Strategic Royalties (GRC) is a company that we recommended to clients back in February of 2015 at a price of $0.62. They had a relatively unique business which was to provide financing to small and medium sized companies in exchange for ongoing royalty payments. The company had recently transitioned into profitability, was generating attractive returns, paid a dividend yield of 8%, and had a compelling growth profile while trading at a valuation well below peers at the time. The company continued to execute its strategy well over the year following our recommendation for which the market rewarded it and its investors with a growing share price. But on April 26th, 2016, the situation changed for us after the company released its Q3 results after market. The numbers (revenue and cash flow) on the report continued to look good but what troubled us was that management had recently made nearly $6 million in follow-on (secondary) investments into companies which only months later were now being classified as distressed. This particular decision was going to cost the company in future quarters but more importantly it reflected in what we saw as a fundamental flaw in management’s decision making process. In this case, it appeared to us that management had made decision to throw new money to prop-up poor investments as opposed to making the hard but prudent decision of accepting mistakes and cutting loses. We knew when we invested in the company that management’s decision making ability was pivotal to success. With our confidence in management shook and future profitability in question, we knew we had to immediately issue a SELL recommendation on the stock even with certainty that the share price would open much lower on the next day.

No surprise to us the share price closed the next day down 35% to $0.52 compared to $0.80 per share immediately before the release of the financial results. With the dividend, the return was about flat or slightly higher based on the original recommendation price but still significantly below where the stock had traded in just the weeks and months before. It’s difficult to SELL a company when you are underwater as the string of a loss and hope of a recovery are powerful motivators for many investors. But we knew that the situation had changed significantly since we recommended the stock. We wouldn’t buy the company in its then current condition, so why should we continue to HOLD it? After issuing our SELL recommendation the situation did not improve for the company. Profitability deteriorated, they discontinued their once attractive dividend and the share price continued slide, trading now at only $0.12 per share down another 77% from where we were able to get out.

Case Study 2: Share Price Down – HOLD or BUY More

Applied Optoelectronics (AAOI: NASDAQ) is a company that we recommended as part of our U.S. research in April, 2016, for a price of US$15.99. At the time the company had 5 straight years of revenue growth, 3 straight years of earnings growth, margins were improving and it was selling leading edge technology into a high growth market. The stock was also trading at a valuation well below peers after factoring in the growth rate. Very shortly after our recommendation the company released its quarterly results and much to the surprise of both us and the market, earnings were well below expectations. The result was a near 30% drop in the share price to $11.70 in a single day. Now anyone investing in the stock market needs to accept the reality of share price volatility, but when a company you own falls by so much in a single day, the general reaction is one of panic and this will cause many investors will instantly hit the SELL button. This is a very understandable reaction and in many cases selling will be the right move to make. But rather than being reactionary, we needed to understand what happened in the quarter, review the business fundamentals in the context of this new information, and go back to the original reason that we recommended the company in the first place.

Revenue growth in the quarter was actually tremendous but the company reported a net loss compared what was expected to be strong profitability. The issue came down to a significant increase in costs, partly resulting from redesign activities associated with cost reduction efforts as well as higher R&D expenses. Based on our analysis, it appeared that this was just a short-term bump in the road in what was still a healthy business selling into a growing market. We knew when we recommended the company that there would be lumpiness in quarterly performance, and while this was much more than we expected, the longer-term investment thesis and fundamentals had not materially changed. Based on this analysis, we advised clients to HOLD their positions after the disappointing quarter and then we re-initiated our BUY recommendation after the next quarterly report was released and it was clear that the company was back on track.

Applied Optoelectronics recovered very quickly after its quarterly blunder and went on to close 2016 at $23 per share, up 44% from our original recommendation price. The stock then went on to be one of the top performing stocks on the NASDAQ for the first half of 2017 and today trades at over $60 per share, or 275% above where we recommended it (much better than the 26% loss we would have incurred had we sided with the market and overreacted to the quarterly report).

Case Study 3: Share Price Up – Get Out and Take Profits

High Arctic Energy Services (HWO: TSX) was recommended in our research in January, 2013, at a price of $2.36. Unlike the name implies, the company had nothing to do with the high arctic. It also wasn’t your typically oil & gas service company which is an industry we generally avoid due to the cyclicality and highly volatile share prices. This company was different. Most of its business was in Papa New Guinea where it provided drilling and equipment rental services to what we saw as a very attractive market.  The company’s work in the region was primarily provided under multi-year contacts with strong demand in the area underpinned by a US$19 billion LNG (liquid natural gas) plant being constructed in partnership between ExxonMobile and OilSearch. Unlike its North American counterparts, High Arctic’s revenue and cash flow profile was relatively stable. The company also had a balance sheet flush with cash, no debt, and traded at an incredibly attractive valuation relative to earnings.

The stability of High Arctic Energy was certainly tested when the energy sector started to fall apart in 2014 and oil prices fell from over $100 per barrel to a low of under $30 over the subsequent 2 years. In spite of the challenging industry conditions, the company continued to produce strong growth in revenue and cash flow while its North American peers were reporting net losses and struggling to keep afloat. High Arctic added more and more net cash to its balance sheet, eventually amassing a substantial cash war chest which we expected would be used for reinvestment back into the business, to pay dividends, and to pursue accretive acquisitions.

Finally in February of 2017, when the share price was trading at $6.20 per share (up 163% from the original recommendation not including dividends) we elected to issue a SELL recommendation and crystalize our profit. Why did we decide to SELL when it appeared things were going so well? As with the other examples, we went back to the original reason we liked the stock and compared that profile to the company that we saw on that day. The fundamentals of the business were still strong, but management had eventually decided to invest the company’s excess cash into an acquisition. Unfortunately, rather than finding a way to invest more into what was working well for the company they decided to take a contrarian approach and purchase oil & gas services assets in North America where the profitability profile was highly uncertain.

For us, this shifted the focus of the company, from a very unique and relatively stable overseas operator to what appeared now to be a fairly standard North American energy services business. This is not what we signed up for and with the share price up over 160% since our initial recommendation, and 50% over the previous 6 months, we were also now holding a stock that had become more expensive on a price-to-earnings basis. It wasn’t an easy decision to SELL a stock which at the time had such strong share price momentum behind it. Focusing on the business fundamentals and original reason we became shareholders allowed us to remove emotion from the process. Within a few weeks of our SELL recommendation the share price started on a steady decline and is now down 40% from the day we decided to exit.

Case Study 4: Share Price Up – Keep Buying More!

Warren Buffett once said that his favourite holding period for a stock is forever. This is clear departure from the way a lot of people trade try to invest today which is more focused on constant trading and trying to capture quick returns. What Buffett means is that some companies will continue grow and thrive over multi-year and multi-decade periods and as long as the investment thesis remains intact then you never have to SELL. These are the best companies to own. For at least the past 6 years, we think that Brookfield Infrastructure (BIP.UN) has fit this profile.

We recommended Brookfield Infrastructure in March of 2011 at a price of $14.40 per unit (adjusted for a 3 for 2 stock split in Aug 2016). The company was a dividend growth play. It paid a yield of close to 6% at the time and income distributions were increasing. Underpinning these income distributions were utility-style assets with 80% of cash flow derived from regulated or contracted revenue. In spite of being a stable, utility-like business, it was also a growth stock with a large backlog of organic growth projects and a successful acquisition strategy. Investors had the opportunity to purchase unit in this company at what we considered to be an attractive valuation of about 15 times free cash flow.

Since the time of our recommendation, the company’s stock price has been on a steady rise upwards and trades at over $55 today. This is a 281% increase over the recommendation period or an average of 23% per year before accounting for dividends. To put this into perspective, the TSX index overall has averaged about 1% per year over this period before dividends. What makes this even more notable is that we recommended the company as part of our conservative income research…large, established, and stable companies that pay a nice income yield and let you sleep at night.

Over the past 6 and a half years, the question has been brought up many, many of times of whether or not clients should continue to BUY or lock in profits and SELL their positions. When you are up 50%, and then 100%, 150%, and then over 200% on a stock, there is a concern that these attractive profits could be lost and a tendency to cash out and protect your gains by moving capital somewhere else. In some cases, this would be a wise move, but the decision to SELL or BUY once again comes down the fundamentals and an analysis of why the price has been rising. We have updated Brookfield Infrastructure 17 times since our recommended on 16 of these occasions reiterated our BUY recommendation on the stock (most recently in August of this year).

Why continue to BUY a stock that has already appreciated so much? Put simply, a thorough analysis of the company indicated to us that the original investment thesis was still intact. The rising price was not driven by investor exuberance and market momentum but rather by double-digit growth in cash flow and income distributions per unit and an outlook for future growth that continued to be strong. It’s nice to cash out on a big gain but by focusing on the fundamentals over the stock chart, you can stay invested in a stock which continues to generate solid year-over-year performance. In the case of Brookfield Infrastructure, since 2011 the company had paid over US$7.00 in income distributions to its investors representing over half of the original purchase price.

Paul Andreola (Small Cap Discoveries),

A former investment advisor and serial entrepreneur, Paul has been profiting in the small cap space for over two decades. His relentless focus on growing, profitable small caps has uncovered some of Canada’s biggest winners in the last few years. Paul started Small Cap Discoveries with co-editor Brandon Mackie to share his ideas and help retail investors reach their investing potential.

Paul uses a focused criteria in his research: high revenue growth, fundamental cash flow and earnings in micro-cap and small cap companies. His successful track record in getting 100%-1000% returns from his stocks comes from studying financial statements and industry reports and using his street sources, so by the time he talks to management—he knows almost as much about the company and the industry as they do.

Paul has honed his skills from 30 years of varied small cap experience. He has been the co-founder of two public companies and CEO and director of another—all three in the technology space. He also helped raise the initial funding for each. This experience gives him an important view when he is interviewing management for newsletter stock picks. He knows the pitfalls and mistakes that management teams must avoid.

Paul also spent 10 years as a retail stockbroker, again focusing exclusively on small caps. He knows the capital structures that work and don’t work in the micro cap space. He knows the company, the industry, AND the stock. His goal is to be first in identifying small cap growth stocks before they are discovered by the broader market. That involves hours of exhaustive fundamental research, and then drawing on a tight network of experienced and senior contacts.

There are no resource stocks in Paul’s portfolio—which is where most of Canada’s small cap crowd focuses. The Canadian micro cap market – especially the non-resource space – is a huge opportunity for investors willing to dig deep and uncover these hidden gems. Paul understands the intricacies of the public markets and the challenges small cap companies face. He is now funnelling all that experience and discipline into a newsletter called Small Cap Discoveries.

Paul is also the CEO and director of Brisio Innovations a small publicly listed investment holding company that owns many of Paul’s favourite micro cap investments.

Some recent winners –

RX.V ($1.20 – $7.50),
COV.V ($0.15 – $1.40)
CPH.T ($2.20 – $12.50)
PTE.V (0.125 – $1.10) current holding
HTL.V ($0.10 – $0.78) current holding
LTE.V ($0.25 – $1.88) current holding
IPA.V ($0.30 – $1.15) current holding

We review financial statement (quarterly and annual reports) of every company in Canada. We do not use screening software. We do it the old fashioned way because we find that screening software will miss the occasional company and those likely turn out to be the better opportunities because the lower number of people seeing them. Also by manually reviewing financial statements we can find the accounting adjustments that could overstate or understate the true state of the company.

We have a strict set of criteria that we use to sift through the thousands of Canadian listed companies. We look for growth, profitability, shares structure, share ownership and ultimately price to value. It’s hard to value growth companies, especially small ones. Many of these companies are small, illiquid and difficult to analyse as there is not much information available. But because we have been doing this for many years we know where to look and more importantly what to look for to get the info we need to make the proper calculated decision.

The first screen only puts the company on the work list. Then the real work begins. We dig into the financials, management history, capital funding history, structure and a host of other things. We start interviewing management and sometimes talk to customers, shareholders and almost anyone with a history with the company. But we also look at probably one of the most over looked items with publicly listed companies…. “how discovered the company is”.

We believe there is a discovery process that drives the bulk of a company’s share price when it is small. What we mean by this is the process of a company going from investment obscurity to market darling. This can be where the explosive share price growth comes from apart from just how well the company performs. We have a formula to figure out how well known the company is in the investment community.

Most small companies don’t have the means to properly gain market exposure. Little budget, little experience and some with little incentive or need for exposure.

Let’s compare 2 microcap companies….one that is quietly working away building the business by internal cash flow and perhaps management self funding. The other needs constant outside financing to execute it’s business plan, develop their product, finance their losses etc. Who gets the attention of the broker/financial community? Usually it’s the company that can generate the most fees and commissions for the brokers. Financings are the golden goose for most brokerage firms. The weaker, riskier company needing money usually gets the interest of those who then have the ear of the investing community. Out come the research reports and the brokers and management promoting the future of this company. Meanwhile the other profitable little company quietly whiles away in near obscurity.

It’s these obscure little companies that have proven to offer the best risk/reward opportunity for savvy smaller investors. They also offer another advantage for small investors….sometimes they are too small for larger investors. It’s a weird situation. Those investors that very good at micro cap investing become too big for micro cap investing. They have to move up the food chain to bigger companies to be able to move the needle. Therefore a new crop of savvy micro cap investors are needed to take advantage of these smaller opportunities. It’s where Warren Buffett learned his trade. He is now far too big to play with these little companies.

I truly believe it is one of the last areas where small investors have an advantage if they put in the time and effort.

Paul’s Explanation of “Reverse Engineering the Perfect Stock” –

We are going to tell you about the perfect stock that could make you millions of dollars. Few investors know about this stock even though it’s a multi-bagger in plain sight. Okay, on with it – what is it!? Here are a few clues…

The stock is a micro-cap, under $20 million-dollar market cap, and has had three straight years of operating profits. The company is rapidly growing at over 25% per year, all of it generated organically.

The company has high gross margins at 75% and a scalable business model, allowing operating earnings to grow at a 50% clip.

The company’s industry is experiencing secular tailwinds and growth is expected to accelerate over the next few years.

Being a first mover, the company has no competitors in its niche and new entrants have failed to displace this company because of switching costs and the mission-critical nature of its product.

The combination of pricing power and lack of capital requirements allow the company to achieve extraordinary returns on its invested capital, well over 100%. The company is debt-free and funds its growth entirely from operating cash flows.

Insiders collectively own 40% of the company and the CEO has a 25%+ stake. He bought in with his own money 5 years ago and has added to his stake through open market purchases.

Management has maintained a clean share structure consisting of less than 30 million shares outstanding and no warrants or preferred shares. The low float and small size of this company have kept its stock off the radar of institutions, which own less than 10%.

We all know there is no such thing as a “perfect stock.” That said, we believe there exists certain characteristics that form the DNA of any investor’s dream: a multi-bagger than you can hold on to for years.

What follows is our list of 14 such qualities, organized by key fundamental, business model, and technical criteria (note we use stock/company interchangeably throughout). Enjoy!

Key Fundamental Criteria:


Profits are the lifeblood of any company and cash flows generated by the business ultimately determine the value of your investment.

A company that can fund itself internally avoids financing risks, which can cause massive losses through dilution or excess debt. While bio-techs prove positive cash flows are not necessary for success, working with profitable companies will simplify your valuation process and margin of safety assessment.
At a minimum, we will want to see two solidly profitable quarters and preferably a 3-year track record of profits (or more!).

Rapidly Growing

Assuming a company is generating returns on capital above the costs of that capital, growth is enormously beneficial to the company and its shareholders.

New products, customers, and business lines typically bring more profits and drive the company’s intrinsic value.

Ideally, all of this growth should be organic. Too often, acquisitions don’t deliver on their promised synergies and yield much of their value to the seller through premiums paid. We will want rapid organic revenue growth, a minimum of 25% year-over-year.

Attractive Valuation

The key to investing is not finding the best companies, but rather the largest discrepancies between price and intrinsic value.

Buying at a low valuation provides downside protection in the event your thesis does not play out, while allowing for huge upside if things go well. Valuation is more art than science, and finding the most useful metrics to employ can be tricky.

Our valuations usually begin with an adjusted Enterprise Value/EBIT multiple, which incorporates the company’s balance sheet and strips out non-operating items to better present true earnings power.

We will want this multiple below 10 and ideally below 7 – the lower, the better.

No Debt / Financing Requirement

Debt can juice a company’s returns but often leaves the business vulnerable to the unexpected: a major customer loss, a regulatory change, or a patent infringement suit.

This situation is made worse when the market knows an equity raise is coming, effectively holding the company hostage to its share price. Investing carries enough risk as it is – crossing off dilution/bankruptcy risk is key to putting the odds in your favor.

Example: A $10 million dollar market cap company has $6M in debt, no cash, earns $2 million dollars a year in EBIT, and trades at 8X Enterprise Value/EBIT.

If the company suffers a major contract loss which cuts EBIT in half, you would face an 80% loss on your investment assuming the company maintains its valuation multiple(1 million X 8 = 8-6 = 2 million).

High leverage magnifies negative events in a big way.

We will want our company to have no debt and plenty of cash in the bank for growth investment. The company should have no need for future debt/equity raises and fund itself entirely through internal cash flows.

Durable Competitive Advantage

Durable competitive advantages, or economic moats as Warren Buffet calls them, are derived from only a handful of sources: brand power, switching costs, patent/government protection, and network effects.

Economic theory holds that in absence of one of these forces, competitive pressure will reduce all company’s Return on Invested Capital (ROIC) to the cost of capital.

Sources of economic moats are not all created equal. Government protection often proves unsustainable and brand power can be just as easily eroded in some cases.

We will want our company to benefit from switching costs, network effects, or both. Banks, software providers, and business service companies are all beneficiaries of switching costs. Social media and auction platforms are prime sources of network effects.

High Returns on Capital / Low Capital Requirements

The less capital investment a company requires to keep its competitive position, the more profits that are left over to invest in growth or be returned to shareholders.

By nature, some companies require little capital while others require seemingly endless amounts to stay afloat.

This intrinsic quality, along with competitive positioning determines the Return on Invested Capital our company can achieve. Return on Invested Capital (ROIC)  is a key value driver – the higher the ROIC, the more shareholders stand to benefit from growth.

Example: Capital-light/high-ROIC businesses include software, database, and franchising companies.

Capital-intensive/low-ROIC investments to be avoided include railroad companies, automotive manufacturers, and above all, airlines. By requiring our company to have a ROIC above 50%, we will be big beneficiaries from any growth the company generates.

High Gross Margins

Gross Margin (GM) refers to how much profit is left after the direct costs of products/services are covered. The higher the gross margin, the more profits will accelerate with sales growth.

Example: If Business A has 75% GMs and Business B has 25% GMs, Business A will experience three times the impact on profits from each dollar of new business as compared to Business B.

High gross margin companies include patent licensors, medical device manufacturers, and pharmaceutical companies. Examples of low gross margin companies are automotive suppliers, construction contractors, and retailers.

Gross margins will vary widely based on industry but in general, the higher the better. We will want our company to have gross margins of at least 50%.

Scalable Business Model

Scalability refers to a company’s ability to leverage its infrastructure as it grows. A good measure of this is the Degree of Operating Leverage (DOL), or the percent change in EBIT divided by the percent change in revenues.

Example: Once a Software-as-a-Service (SaaS) company invests in the infrastructure to create and sell its software, each incremental subscription can be delivered at virtually no additional cost.

Compare this model to a restaurant, which must pay rent, labor, and food costs with every location opened. Software and database companies are often scalable, while restaurant operators and manufacturers tend not to be.

Ideally, we will want our company’s operating expenses to grow at half the rate of revenues or less (DOL >= 2).

Non-cyclical, Recurring Revenues

Recurring revenues afford a business the advantages of predictable cash flows to base investment decisions on and high lifetime customer values.

Recurring revenues also aid investors in projecting future cash flows and performing valuations.

A stable, non-cyclical business offers the similar advantage of predictable cash flows, while offering safety in case of a sharp economic downturn.

Example: Any business with a subscription model, such as SaaS or security monitoring, is likely to have recurring revenues. Food, tobacco, and alcoholic beverage companies are all classic examples of recession-resistant businesses.

We will want a business with over 50% of their revenues recurring and a low sensitivity to general economic conditions.


Much like large companies forge their own anchors as they grow, small companies have the law of small numbers on their side. Small size often offers a long runway for growth and magnifies each positive development.

Example: Think of a SaaS company doing $10M per year annually that announces a $2M contract. This business becomes 20% more valuable over night, and perhaps far more given the operating leverage inherent in software.

We will want to stick to companies below a $300M market cap, and ideally less than $50M.

Low Float / Clean Share Structure

Low float (freely tradeable shares) results from a low share count, high inside ownership, or a combination of the two.

From a technical standpoint, a low share float can lead to massive price increases as investors rush to bid on a limited supply of shares.

On a more fundamental level, the float is a reflection of how management has financed the business in the past and their relative ownership of the company.

We will want no more than 50 million shares outstanding and preferably less than 30 million. The float should be significantly lower due to insider ownership (discussed below). We will also want to see a clean share structure, with low or no warrants or exotic convertible instruments.

High Insider Ownership

We want a management team that behaves like owners and this is not possible unless they ARE owners.

For the micro-caps we are interested in, we will want to see insiders collectively owning at least 30% of the company, with the CEO himself owning at least 15%.

It is also important to assess how management got their stakes – did they buy in with their own money or was it given to them through options and share grants?

Management adding to their stakes through open market purchases is often a big plus. This demonstrates insiders believe in the company’s future and you should too.

Low Institutional Ownership

For a variety of reasons, many institutions cannot invest in the small-caps we are interested in. Some have restrictions against stocks under $5 or companies that trade on the Toronto Venture Exchange (TSX V).

With all the desirable qualities discussed thus far, institutions will be drooling over our company waiting for the company’s size/liquidity to reach their buying criteria.

When this happens, look out! Triple digit gains are quite likely as institutions pile into a “must own” stock.

To leave this big catalyst open, we will want to see institutional ownership under 10%.

Secular Industry Tailwinds

Never forget to look beyond the fundamental and technical factors to understand the underlying trends in the company’s industry.

Beyond a company’s own efforts, secular industry tailwinds are often necessary to sustain our 25+% revenue growth target.

Industry tailwinds also have the bonus of attracting investor attention, which can lead to big gains as our company is viewed as a unique play in a hot sector.

Example: Organic foods, mobile applications, and network security software are all industries undergoing secular growth phases.


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