I’m a value investor at heart. But sometimes it pays to invest in stocks with plenty of momentum. This micro-cap stock fits the bill.
My dad was a large-cap portfolio manager at a Boston based investment management firm. And my mom worked for the global bond powerhouse, PIMCO, as a credit analyst.
As a kid, I was interested in making lots of money, and the stock market seemed like an excellent way to do it.
So I would pester my dad and mom with question after question. My dad took great pleasure in teaching me the investing basics and patiently answering my questions.
He was a value investor. As such, he mainly focused on buying out-of-favor, “cheap” stocks.
He had absolute conviction in the strategy and the data supported him at the time and still supports him to this day (despite the recent 10-year period of underperformance by value stocks).
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According to Northern Trust Asset Management and Kenneth French Data Library, value stocks have outperformed the market by 3.1% per year over the long term (1926 to 2020).
As a budding value investor, I was trained to look for situations with “a little hair” on them. A stock that has gone nowhere for a long time. A down-and-out stock that everyone else has ignored.
Wait for the reversion to the mean.
When the company reports better-than-expected results and the stock pops, sell and recycle proceeds into the next cigar butt (as Benjamin Graham would say).
Why Momentum Matters
It took me a long time to recognize the importance of momentum—both in the fundamentals of a company’s business and in the stock price.
Usually, a stock that is down-and-out will stay down-and-out.
A company that is posting disappointing fundamentals will usually continue to do so.
You are much better off looking at stocks with positive momentum.
The below chart was shocking to me.
Over the long term, “buy at all-time-high investors” outperform “buy and hold” investors.
But it reinforced the message that momentum is important.
I focus on micro-cap stocks and the chart below shows that it pays to invest in micro-caps with high momentum.
According to O’Shaughnessy Asset Management, investors who buy the highest momentum stocks and short the lowest momentum stocks would generate an annualized excess return of 23.9% in micro-caps.
I prefer to focus on just buying high momentum micro-caps (shorting micro-caps is difficult).
I don’t ignore valuation. But I’m willing to buy a stock at its all-time high as long as its valuation is reasonable.
Buy this Micro-Cap Stock at All-Time Highs
My ideal set-up is a cheap stock with high momentum.
Consider Medexus Pharma (MEDXF), a Canadian specialty pharma company.
My Cabot Micro-Cap Insider advisory subscribers, who bought the stock when I originally recommended it back in April 2020, are up 221% … but the stock still looks cheap to me.
It is trading at a price to free cash flow multiple of 12.4x yet it grew revenue 43.9% in the last quarter. Strong growth and free cash flow generation should continue in 2021.
If it traded in line with peers, it would be worth $15. And that is why I have no problem buying the stock at its all-time high of 5.65 today.
In fact, I just bought more earlier in January.
To learn what other micro-cap stocks I’m recommending today, click here.