Tim Heitman is a longtime investor and former analyst who has spent more than 40 years around the markets, including time spent at Fidelity when Peter Lynch was managing the Magellan Fund. He was a Skull Session guest in August 2023. We are publishing this throwback Skull Session to pair it with Tim’s written Q&A session we just completed, and are posting tomorrow. I learned that much of his process comes down to doing the simple things better than everyone else. Tim is a numbers guy, so he starts with the financials. I know this from my conversations with him. But he also wants to intimately understand the business, and doesn’t rely on screens to hand him ideas.
That approach becomes especially interesting in microcaps and nanocaps. Tim argues that this is still one of the most inefficient parts of the market because there simply aren’t enough investors paying attention. The information is public, but that doesn’t mean it is being processed. A company can put something important in an SEC filing or press release and have virtually nobody react to it. That creates a very different opportunity set from large caps, where thousands of analysts, funds and algorithms are watching every quarter. The trick is identifying the change before the broader market catches up. Some of the things he looks for include:
A new CEO
A better sales process
Improving margins or capital allocation decisions
One of Tim’s favorite ideas is the “one hour analysis.” The goal isn’t to become an expert on a company in 60 minutes. It’s to consistently look at the same important things so you can quickly decide whether there is enough here to warrant deeper work. He starts with cash flow, works through the financial statements, looks at the proxy and ownership, then spends time understanding how the business actually gets customers and makes money. When he talks to management, he likes asking simple questions such as, “What problem are you trying to solve and why did you choose this way to solve it?” He focuses on what he refers to as the pre pre-mortem: if we come back three years from now and the stock is still sitting at the same valuation, what probably went wrong? Those questions can tell you far more than another 20 pages of management talking points.
The challenge with microcaps is often not finding the opportunity, but having the patience to wait for the market to recognize it. A stock can sit at 20 cents for two years while the business quietly improves, and then suddenly move to 60 cents when the market finally cares. As Tim put it, “it doesn’t matter until it matters.” That is both the opportunity and the frustration. You can do the work correctly and still have to wait for the incremental buyer to show up. But that’s exactly why I continue to think the smallest companies are worth studying. When you can identify a real change before it becomes obvious in the numbers, you are not competing on the same playing field as everyone else.
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Skull Sessions is a collaboration with Geoinvesting.com, a full-stack microcap research platform and MS Microcaps LLC , home of the Microcap Quality Index (MSMqi).
Key Takeaways
Cash flow is more important than ever. A good business can still be a bad investment if its balance sheet and financing needs create too much risk.
Always look at the capital structure. A decent business with a terrible capital structure can still make for a terrible stock.
Separate business risk from balance-sheet risk. Rising rates or a weak economy do not affect every company in the same way. Debt levels, cash balances and financing needs matter.
Management ownership means something. CEOs with meaningful ownership have more incentive to think about the long-term value of the stock.
Don’t let the macro story overwhelm the company-specific facts. The market often treats entire industries as if every company has the same exposure, even when balance sheets and business models are very different.
Be careful with valuation precision. A valuation is ultimately an opinion about what multiple the market will assign to future earnings or cash flow.
Think in scenarios rather than exact price targets. The more useful question is whether a company can become substantially larger over the next three to five years and whether today’s price gives you enough room for error.
Gross profit dollars can tell a better story than margins alone. Falling margins are not necessarily bad if they are part of a strategy that produces much faster growth in gross profit dollars.
Look for identifiable business fixes. Changes to sales systems, distribution, logistics and operating processes can create significant improvements in a small company.
Catalysts can come from execution, not just headlines. A new management team that actually fixes a broken business can be enough to change the investment story.
Stocks Discussed
MOJO (OTC Markets): Discussed as an example of overlooked information in a nanocap, including stock buybacks, a reduction in authorized shares, its coconut water business and a planned energy drink line.
FCNE (OTC Markets): Discussed as a tiny Texas bingo-card business with a strong market position, recurring cash flow and a sizable dividend.
AMZN (Nasdaq): Used as an example of why investors should focus on gross profit dollars and the economics of growth rather than simply reacting to declining gross margins.
TACT (Nasdaq): TransAct Technologies was discussed in the context of a new CEO and the potential for a sales-force overhaul after years of weak sales execution.
MMTRS (OTC Markets): Mentioned as an obscure, illiquid royalty investment that was eventually revalued as investors recognized the value of its recurring royalty stream.
MAR (Nasdaq): Marriott was used as an example of how a larger, cash-generating business can have very different balance-sheet and macro risks than a highly leveraged microcap.
MAMA (Nasdaq): Mama’s Creations was discussed extensively as an example of a microcap where improving gross margins and operational execution could materially change the earnings power and valuation of the business.
