This article is authored by MOI Global instructor Eric Gomberg, founder of Dane Capital Management, based in New York.
Dane Capital Management runs a long-biased, long-term oriented, concentrated value/special situations strategy. We attempt to identify significantly mispriced securities with an asymmetric risk/reward profile. A significant portion of our research efforts are focused on SPACs, which we believe are underfollowed and prone to mispricings.
“How old would you be if you didn’t know how old you are?” –Satchel Paige, Hall of Fame Pitcher
At Dane Capital we often ask ourselves a stock market equivalent to the above quote: “What price do we think a stock would be trading at if we didn’t know the price?”
As investors, and as human beings prone to biases, we often look at stock prices or a trading multiple and use that as a jumping off point for rationalizing why a stock trades where it trades. In behavioral economics this concept is known as anchoring or the anchoring effect, in which an individual takes an initial piece of information and overweights it in his decision making process.
We find that with stocks, investors frequently take an initial piece of information and based on that information (stock price, EV multiple, etc.) create a narrative to justify that stock price. After all, if one believes in efficient markets, then the stock price should reflect all available information regarding the company that one’s analyzing.
While we believe that markets are efficient over time, in the short-term, in our view, stocks can be significantly mispriced. It is our job as analysts to avoid the temptation to creative a narrative to justify a stock price, but instead to take all available information regarding fundamentals, industry dynamics, comparable multiples, etc., to create our own narrative, and in so doing, come up with an appropriate estimate regarding a company’s fair value. If we didn’t know what the price of the stock was, what do we think it would be?
In speaking with the managements of several of the companies in which we have positions, many have noted that a favorite question among investors that they meet is, “why is your stock so cheap?” Sometimes there are justifiable reasons (although we certainly believe that is not the case with our holdings), but other times there are reasons that are largely unjustified. Yet, investors still often have a hard time separating the price and multiple they see in the market from what the fundamentals would suggest as fair value. Admittedly, cynicism is often rewarded, and many cheap stock are cheap for good reason.
While Dane Capital has no aversion to owning great or very good companies that can be bought at reasonable prices and which have the potential to compound over time, our primary focus, as described above, is on trying to identify severe mispricings – those occasions where a stock price is detached from its fundamental value. In this process, we also ask ourselves: “why does this mispricing exist?” and “what do we understand that the market is missing?”
A reasonable question is where to look for such opportunities because we believe most stocks do trade in a range near where they ought to. Searching for such opportunities can be a lengthy and grueling process – and usually is. Uncovered/underfollowed small-caps or micro-caps represent one area. Historically, another fruitful area has been in spin-offs, where one often finds a spin-co which may be too small for its historic owner to own, resulting in forced selling, or its exclusion from an index, also resulting in forced selling, or it simply being ignored by the market, as an orphaned company with no research coverage.
At Dane Capital we have spent a disproportionate amount of time researching SPACs. As opposed to conventional IPOs where there is typically a lengthy roadshow and thorough price discovery SPACs all start around $10 and could be worth $2 and could be worth $20 (or something in the middle). There is generally little initial sell-side or buy-side research and they tend to be widely ignored – often for several quarters. There are often peculiar trading patterns post SPAC merger closing, resulting in a compelling investment opportunity.
In our upcoming Best Ideas 2019 presentation, we will discuss NRC Group (NRCG), which participates in the emergency/waste services industry (standby services, emergency services, and waste disposal). It a business that we really like because virtually all of its revenue is annually recurring and non-discretionary across thousands of customers, providing a high level of visibility.
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