Don’t Be A Chicken
A few years ago I went on a company due diligence trip with a friend of mine who manages a microcap fund. We spent the morning with management and the afternoon visiting a few of their customers.
At dinner that evening we replayed the day’s events. Towards the end of the discussion my friend says, “You know the thing I like most about this company is their customers would really be screwed without their product.”
I let what he said sink in for several seconds and replied, “that is brilliant”. I had never really thought about it that way, and rewrote it down in my my notes as follows:
Invest in companies whose products or services are so relied upon that if they didn’t exist it would cause their customers a lot of pain
I have tried to apply this powerful statement to every one of my investments ever since.
A Simple Concept Sharp as a knife
Its greatness is its simplicity, and just like a sharp steak knife, it cuts away the fat and BS very quickly. In a manner of seconds, you can apply it and come away with some worthwhile conclusions.
In general, a business’s product or service should be a pain reliever to its customers.
“One of our directors said very simply, ‘We should make a list of everything that irritates the customer, and then we should eliminate those defects one by one.’ That is the way to compete in a service business.” – Charlie Munger
The best businesses relieve so much pain, that their customers couldn’t imagine operating without them.
Earlier this year I visited another company and one of their customers. In preparation I emailed the CEO of the company and asked him if he were in my shoes what questions he would ask the customer.
The CEO said if he were me, he would ask the customer what type of ROI they were seeing with the product and also how disruptive it would be to the customer if they didn’t have the company’s product.
Hmm, there it was again.
Invest in companies whose products or services are so relied upon that if they didn’t exist it would cause their customers a lot of pain
A few of you might sarcastically be thinking: “It would really be painful if we didn’t have electricity, water, heat, so you want me to buy utilities?” Or perhaps you’re thinking, “Well using that statement you would never invest in Coke or any big consumer brand because you don’t necessarily need their product right? If Coke went away, I’d just buy Pepsi or some other sugary concoction.”
I believe well-known brands, especially those with a cult following, do fall under the pain reliever criteria.
Useful when Used in Small Companies
The point I would make is you might find some areas of the market, especially with larger companies, where the statement above doesn’t exactly fit. But I believe it is very useful in qualitatively evaluating small companies like microcaps.
The market is filled with companies whose products or services have an abundance of look-a-like competitors with low switching costs. It is rare to find a small company whose product or service is very lucrative to its customers.
Few small companies will make it over this high qualitative hurdle. Many might argue that when expressed in the literal sense it screens out too many, but few could argue when you find a small company that fits, it is likely an exceptional business.
Don’t be afraid to say no to 99.9% of investment opportunities. You only need to find one great company, before others, to change your life. Extraordinary returns follow extraordinary discipline. An investor’s goal should always be to make as few investment decisions as possible. Keep your hurdle rate high and embrace inaction.
Here’s Why You Don’t Want to be a Chicken
Chickens will eat anything you put in front of them. They will eat insects, bugs, meat, fruit, vegetables, fish, and yes even chicken. They have no self-control and will even eat their own eggs and feces.
A hawk can see up to 8x more clearly than the sharpest human eye. To put in comparison, if you had a hawk’s vision you could see an ant on the ground from on top a ten story building. A hawk’s eye is so large that it occupies a big portion of its skull. The hawk knows what it’s looking for.
The visual capabilities let the hawk distinguish the size, shape, and speed of the potential prey so it can recognize, target, and capture it quickly. Don’t be a chicken, be a hawk.
Be picky.
As you fly above the investment world looking for opportunities, develop tools, strategies, even statements like the one discussed in this article, that you can apply quickly to evaluate opportunities. Know what you are looking for so you can develop the vision to recognize an opportunity quicker.
This article was originally published on MicroCapClub.com and is reprinted here with MicroCapClub’s permission. MicroCapClub is an exclusive forum for experienced microcap investors focused on microcap companies (sub $300m market cap) trading on United States and Canadian markets. © 2016 MicroCapClub LLC
About the Author
Ian has been investing in microcaps for 15 years and has been a full time microcap investor since 2008. Ian looks to invest in great management teams running great businesses with a moat. He tries to invest in the best 5-6-7 companies he can find at all times. Ian founded MicroCapClub in 2011 to be a place for “real” and experienced investors in the microcap space to share ideas and learn from one another. When Ian isn’t researching stocks or administering MicroCapClub, you can find him reading, golfing, or shopping at Costco with his wife.
