Hourglass Journal - Microcap (Dis)Advantage, $HMM.A, & Meta Resurgence
“It is what we know already that often prevents us from learning.”
Hammond Manufacturing Company - $HMM.A
At the end of December, I covered Hammond Power Solutions as the Watchlist Stock for the weekly Hourglass Journal issue. Now, I’m covering another member of the Hammond family that, even after a huge +150% growth figure over the last year, is still very attractively priced and continuing to grow while improving margins and capital efficiency metrics.
Hammond Manufacturing Company, similar to Hammond Power Solutions, manufactures electrical components. Where Power Solutions focuses on electrical transformers, however, the Manufacturing Company makes electrical enclosures and power strips, as well as transformers.
Topline growth has slowed somewhat after some pulled forward demand over 2021-22, but it continues to grow (6% YoY) from the larger baseline it’s set for itself, with a 3-yr revenue CAGR of 18%. Despite slower growth, Hammond has been able to fund a lot of its profits to the bottom line, with a 64% Dil. EPS CAGR over that same period.
The business fundamentals have also been on the up and up - capital efficiency metrics have improved really impressively over the last 5 years, while the margin profile has also expanded and long-term debt has remained low. The lone concern on the balance sheet is a reduced free cash flow margin that currently sits in the negative. However, the overall quality of the company and the particular volatility of this metric with manufacturers helps to dispel concerns on this front.
Moreover, the valuation on Hammond Manufacturing is extremely attractive - even if the free cash flows were a longer-term concern, there’s a lot of upside potential just from potential multiple expansion. Revenues are nearly double the market cap and just 0.8x the enterprise value of the company while the P/E ratio sits at just 7x. This is largely a benefit of being an under-the-radar Canadian microcap at just $130m, but the improving fundamentals and continued growth make this company one that investors should be paying more attention to.
I think microcap investors with a stomach for the typical volatility associated with a manufacturer have a lot of upside potential with both of the Hammond companies - despite a lot of growth over the last year for both companies, they both actively benefit from wider tailwinds in electrification.
Big or BS?
This is a new segment where I take some sort of narrative from the markets over the last little bit and decide whether it’s actually significant news that investors should be worried about (Big) or if it’s just more noise designed to distract us from the business of actually making money (BS).
I can’t remember ever seeing a larger turnaround of narrative in any company than we’ve seen with Meta over the last few years. At times, it felt like watching an episode of Game of Thrones - first, it’s at the top of its game as one of only a few companies to hit a $1tn market cap. Next thing you know it’s dead, victim of a more than 75% loss in value that had Meta looking like a value stock (or brutally murdered by the inept and power-hungry Zuckerberg, if some columnists were to be believed).
Now, Meta has been revived and is back at the top of the game (a regular Jon Snow, if we’re sticking with the Game of Thrones reference). Once again eclipsing the $1tn mark with a 20% single-day jump after reporting a strong Q4, Meta has had an incredible +400% turnaround story as it’s implemented its ‘year of efficiency’. Significant cost-cutting measures and layoffs are alleviating investor concerns on expectations of continued losses in the Reality Labs division, while the company itself seems to have switched on its topline and user growth levers again with advancements in AI and video reels across its platforms.
Despite how impressive the growth story has been for Meta over thee last little bit, I think a large part of that is due to completely overblown worries on a high-quality company with an exceptionally driven leader. So it’s a bit of a mixed bag. I’m voting that Meta’s resurgence is ‘Big’ news, but that a huge part of that turnaround was a slumping stock price based on complete BS.
Introducing Palanatir Technologies (PLTR)
By- Arny Trezzie and Emanuele Marabella
Perhaps one of the most misunderstood stocks in the market today, Palantir deserves some extra attention beyond what it (unfortunately) got during the meme stock craze. Now having registered multiple consecutive GAAP profitable quarters, I think there’s a lot of confusion on what it is that Palantir actually does.
Initially focused mostly on government and defense work, there were a lot of fears that Palantir wouldn’t be able to penetrate the commercial sector. In it’s Q4 results, which the company announced on Monday, Palantir handily dispelled these ideas - the demand for its API (Artificial Intelligence Platform) in the commercial sector has been significant and was a major factor in generating 32% growth in commercial revenues as well as a 44% increase in the number of commercial customers.
Palantir is positioning itself well to become a huge beneficiary of the AI boom, and yet seems to still be operating under a lot of the (mis)conceptions that investors have previously had on the company. While misunderstood, it’s still not any cheaper for it, with another fantastic earnings call helping the stock to jump nearly 47% on higher-than-expected revenue growth.
The article by Arny Trezzie and Emanuele Marabella is a back-to-basics crash course on everything Palantir, and I highly recommend a read whether you’re interested in investing in the company or not. It is an extremely interesting business either way, and Arny Trezzie of Palantir Bullets is probably one of the best people in the world to tell investors everything about it.
Microcap Advantage & Disadvantage
Investors (and often myself as well) talk about the microcap advantage - smaller starting base, lower expectations, and more attractive valuations associated with the lack of institutional interest.
While I was on a call with my friend Dean, who authorsand is well worth the follow, I started thinking about there is also a bit of a microcap disadvantage. Before I even get too much into this, let me just say I’m still a big believer in microcap investing and I don’t want any one getting after me - I’ve found investors can be antsy about their microcaps sometimes. I also believe the potential growth investors can get from the advantages of microcap investing far outweigh the disadvantages.
However, what I mean when I say the ‘microcap disadvantage’ is the extra consideration and cautiousness that microcap investors need to have with their investors. I’ve become very aware of this as I add more microcap exposure to my barbell portfolio - I barely think about my more conservative positions like Visa or Mastercard on a quarterly basis. At best I skim the quarterly report - if that.
However, positions like SupremeX and, more recently, M-Tron Industries, require much more time. The theses with these less entrenched companies are often more delicate and require much more care and attention. That is disadvantage number one, though as I said, the reward can be well worth the extra effort.
Disadvantage number two is that at some point, at least with most microcaps, investors must analyze when their companies have lost the microcap advantage and to lock in profits. This introduces at least some very basic element of trying to time the position. Specifically, I was thinking about this in relation to Xpel, which has become a posterchild for microcap investing and the epicenter of a strange sort of cult.
Xpel returned massive gains to shareholders who go tin when it was a microcap, and undoubtedly made some lucky people extremely wealthy. However, when I got around to researching it, I believe the company had run into disadvantage number 2 - it had lost the advantages it had as a true microcap. By then, it was firmly in small-cap territory at ~$1.5bn. It’s valuation was more expensive, it was garnering more attention from both investors and competition, and its multi-bagger potential from a base of $1.5bn was looking much more bleak than it was when it was only $50m-$500m.
And I’m not saying that Xpel is kaput or anything. But there was an ideal point for microcap-focused investors to take their profits from Xpel and divert their money back into something that was still benefitting from the benefits of being a microcap - therein introducing the element of timing. It is simply harder to buy-and-hold over the super long term with many microcaps, which can limit compounding potential. This isn’t universal, but can often be the case.
The final microcap disadvantage is simply the volatility and long periods of downswings and poor overall performance in a microcap-focused portfolio. While it can still generate fantastic returns over the long-term for patient investors, microcaps often don’t trade relative to their fundamentals. They may deliver outstanding quarter after quarter and get absolutely no love from the markets for that performance. This disadvantage has some nuance - while this can provide lots of attractive entry points for investors, at some point you also need the stock to start following its growing fundamentals to truly profit off it. During periods where micro- and small-caps just aren’t getting the love, it may take years of underperformance before stocks begin to get rewarded again (reason #84820 that I follow a barbell portfolio strategy).
Again, all of the disadvantages are nuanced and I’m still a firm believer that the benefits far outweigh the cons. But these disadvantages are often very real and something that investors ought to be aware of if they own microcaps or are looking to gain more exposure to microcaps in their own portfolios - it’s going to open up a whole new box of frogs.
What’s New at Hourglass
This weekend, I’m going to be releasing my first deep dive of 2024 on Payfare, which I covered very recently as a weekly Watchlist Stock (check it out here if you want a brief overview of the company and its significant multi-bagger potential).
I’ll also be releasing a podcast episode on Unity Software and my decision to move on from the stock pronto-like, which I hope will help to gleam a little insight into my investing strategy and my (very rare) selling process. So there’s lots of exciting things coming up - keep an eye out on the podcast and your inbox to check them out - I’m particularly excited to release the Payfare research. This is one of my newest positions and I think there’s a lot of upside that’s not being recognized by the market yet.
Till next week, happy investing folks!