We had the pleasure of speaking with Paul Sonkin at his offices in New York. Paul is one of the most prominent value investors focused on micro cap and nano cap investing. He serves as portfolio manager of The Hummingbird Value Funds and the Tarsier Nanocap Value Fund. He is also an adjunct professor at Columbia Business School, where he teaches security analysis and value investing. He was previously a senior analyst at First Manhattan and an analyst and portfolio manager at Royce. Prior to receiving an MBA from Columbia, Paul worked at Goldman Sachs and at the SEC. He is a co-author of Value Investing: From Graham to Buffett and Beyond.
The following transcript has been edited for space and clarity.
MOI Global: What was the genesis of your firm, and how would you describe your investment approach?
Paul Sonkin: I started in December of 1999, so we’re approaching ten years. I had worked at Royce and then I had worked at First Manhattan. First Manhattan did large cap value, and I really wanted to get back to what I had done at Royce — which was micro cap value — because that’s what I really love. I met with Mario Gabelli and said I wanted to manage his micro cap fund. He had this guy who worked for him who had started a partnership, and he said, Why don’t you start a hedge fund and I’ll give you some money and own a piece of your management company? So that was how I really got the start at Hummingbird. It’s just old-school, Graham-and-Dodd-type value investing.
Our largest position is a company called Rand Logistics (RLOG). We believe they’ll do about $0.40 in free cash flow [per share] in this fiscal year ending March. We think that will go up to $0.75 to $1 over time. The stock is at $3-3.25…
We’ve pushed the envelope a little bit, Bruce Greenwald talks about doing an asset value based on replacement cost, and then an earnings power value and an earnings power value with growth. The asset value is really Graham’s “net nets.” The earnings power value would be the low P/E. The earnings power value with growth is where you may be paying a full price for the current earnings power but you are getting all the growth for free. We tend to stay in the first two categories, although we have gotten into situations where we are paying for earnings that we firmly believe will materialize – but they haven’t materialized yet — and then we’re getting a lot of growth on top of that for free. That’s evident in a lot of the positions we have.
Our largest position now is a company called Rand Logistics (RLOG). We believe they’ll do about $0.40 in free cash flow per share in this fiscal year ending March . We think that will go up to $0.75 to $1 over time. The stock is at $3-3.25, so we think it’s a pretty good bargain.
Hummingbird was structured after the old Buffett Partnership and Graham-Newman. There are two sides to the portfolio: there is an arbitrage side, and there is a cheap stocks side. We look to keep to those roughly 50-50, although that’ll change over time. In the last few years, there hasn’t been a lot going on in arbitrage. There are a lot of spinoffs but now that area is pretty well picked over. Liquidations used to be a great area to invest in, and that’s become very picked over. Even in micro cap risk arbitrage, we’ve seen more deals breaking, so that hasn’t been a great area for us.
…you get credit for the money you make your investors, not the losses you’ve helped them avoid. Now that it’s a great time to invest, it’s very difficult, because people have been burned and they’re hesitant to put capital at risk.
On the cheap stock side, it’s just opportunities abound — like a kid in a candy store – because you have all these cheap companies. What we’ve seen in the second and third quarter, the markets have come roaring back. We had a very good second quarter. Our third quarter, though, was pretty stagnant. A lot of the market action that you’ve seen is in the larger, more liquid names. I was talking to someone this morning, and they said a manager would rather buy a $500 million company that’ll go up 20% than a $100 million market cap company without any liquidity that might triple. There are a lot of people that are still very concerned about liquidity. The extremely small companies haven’t really come roaring back yet. We’re off the March lows, but they haven’t had those huge run-ups we’ve seen in a lot of the larger micro caps in the $250-750 million market cap range.
MOI: You wrote in a letter late last year that you thought it was one of the best times to be investing. It sounds like you still believe it’s a good time to be in the micro cap space?
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