Watch a Replay of our Hidden Gems Canada Pre-Launch LIVE, Interactive Q&A Event
Come 6 p.m. ET — join host Chris Hill, lead advisor Iain Butler, analyst David Kretzmann, and special guest Motley Fool co-founder and CEO Tom Gardner as they take any and all remaining questions you may have about Hidden Gems Canada, before our Grand Opening tomorrow morning!
In addition our Q&A session, we’ll also be unveiling Charter Member pricing… revealing the two small-cap stocks to advance from our “Rule Breakers” emerging trend… and peeling back the curtain on a surprising Charter Member bonus perk that could save you thousands.
Note: The question box below may take a few seconds to load. After it does, please enter any questions you have for the Hidden Gems Canada team, and they’ll do their best to answer them LIVE on air come 6 p.m.
Chris Hill: Hi, I’m Chris Hill. Thanks for joining us. I’m going to be your host for today’s Motley Fool Hidden Gems Canada pre-launch live event. Joining me today via phone is Hidden Gems Canada lead advisor, Iain Butler, who also serves as the Chief Investment Officer of Motley Fool Canada; David Kretzmann has spent the last half decade working directly alongside Motley Fool co-founder David Gardner in a good many of the growth-oriented services here in the United States, and David is now taking his talents up north full time as an analyst on Hidden Gems Canada; and we also have in studio, very special guest, none other than Motley Fool co-founder and CEO Tom Gardner himself. Tom actually founded our original Hidden Gems service in the United States 15 years ago now. The four of us are going to be with you for the next 45 minutes to an hour, and we’re going to do our best to answer any and all final questions that you may have about this first-ever small-cap focused service from Motley Fool Canada before our official grand opening tomorrow morning.
Before we do that, a few housekeeping items to note before we jump in. First, you will be able to enter any questions you have directly into the chat box below this video player. You’ll also be able to see questions other viewers have asked, and you can vote up the ones that you would most like us to answer. Second, if you’ve been following along with our Hidden Gems Canada bracket over the past few days, you already know that we have been whittling down out 16 top small-cap stocks to kick off 2018 to eight semifinalists. In a bit, we’re going to reveal the two stocks that advanced from our fourth and final 2018 emerging investment trend Rule Breakers, so you’ll definitely want to stick around for that. I know a lot of you have questions about pricing. I promise, we will be revealing our special charter membership price toward the end of this broadcast. I’ve already seen it, and I can say right now, I really think you’re going to like what you hear. One final thing: the powers-that-be have asked me to let you know, because of some of the volatility around small cap stocks and the low trading volume that some of these recommendations will have, we’re going to be making just 2,000 seats available during this grand opening period. So, you will definitely want to learn as much as you can today to make a fast, fully informed decision before spots run out. With that said, let’s jump right in with some of the questions.
Tom Gardner, I have to start with you. I’m going to put you in the way-back machine, take you back to 2003. Tell me about some of your thinking. At that point, you and your brother David had already launched Stock Advisor, the first investment newsletter stock-picking service at The Motley Fool, 2003. A couple years after that, you start looking at small caps and start thinking about the ideas for Hidden Gems. What was some of your thinking, and to what extent did it have to do with your excitement about small-cap stocks?
Tom Gardner: Well, all of the data, or so much of the data, shows that small-cap stocks are the best-performing area of the stock market, and that’s in stock markets worldwide. And that makes sense. The best emerging companies, they’re becoming more relevant, they have more room to grow, they, on average, have higher growth rates than the market indices or the large companies in the marketplace. In fact, if you look back historically in the U.S., go back 90 years, the smallest slice of public companies has out-performed the largest slice of public companies by 4% per year. And anyone who’s mathematical or has been investing for a while knows how massive that gap is. Anyone who doesn’t should just type into an Excel spreadsheet or their calculator what happens when you grow 13% a year instead of 9% a year. In any individual year, it might not seem like much, but when you compound that and get exponential growth, it just goes ballistic. So, small caps are the best place to be investing for long-term investors, and that was the spirit of Hidden Gems. There just isn’t very much coverage of these companies, either. They’re generally not well-known to the large banks or Wall Street analysts. Big financial service analysts around the world are covering the larger companies, and that means there’s inefficient pricing among small companies, and they are Hidden Gems.
Chris Hill: Iain Butler, let me go to you, can you briefly describe membership in Motley Fool Hidden Gems Canada? What should folks expect that’s going to be like on a month-to-month basis if they join in?
Iain Butler: Sure thing, Chris. Right off the bat, as soon as you sign on, we’ll have the finalists from our bracket competition waiting. These will serve as our first four official recommendations. From there, members won’t have to wait long for our next official recommendation to be released. We plan to release it on the first Friday of February. This will be a Canadian recommendation and, indeed, each Friday of the month, a new Canadian recommendation will be released from here in. This will be followed by a discussion of our watch list on the second Friday of each month, our official U.S. recommendation on the third Friday, and then some special multimedia content — which is something I’m really looking forward to and something that’s very unique to this service — is going to come on the fourth Friday of every month.
Hill: Why the focus on the U.S. market as well? Also, small caps is one of those categories that people have different definitions of what the market caps look like. What will you be looking for in terms of market caps there?
Butler: For sure. The simple answer on the U.S. front is, it’s a bigger pond in which to fish. The U.S. is a much bigger, much more diverse market than the Canadian market, and it offers companies and sectors, frankly, that the Canadian market just doesn’t have great exposure to, namely technology and healthcare, which are both, especially when we’re talking about small-cap stocks, pretty exciting areas, to use that pond analogy, to go fishing in. I think we’re excited to broaden our horizons. I have a personal feeling that Canadian investors are overly focused on the Canadian market, which, especially in the small-cap world, tends to put them into the resource sector, which can risky and disappointing, to say the least. I think this is a unique offering that we’re providing.
In terms of company size, on the Canadian side, we’re going to be looking at companies, at the lower end at about $50 million market cap, and at the upper end, $2 billion. And on the Canadian side, it’s been my experience that that’s more or less a typical definition. I come from the institutional world, and that was the definition that was applied throughout the industry. I feel pretty comfortable that’s going to provide a lot of rocks to turn over. On the U.S. side, given the magnitude and the scale of the companies on offer, we’re going to be looking at a lower end of about $100 million market cap, and at the upper end $5 billion.
Gardner: Iain, can I ask you a question?
Gardner: Why are the resource companies in Canada, the small-cap variety of resource companies, risky and disappointing? Those were your descriptions.
Butler: Well, you pull up a financial statement for a good number of them, and there’s nothing to look at. They are, for the most part, a plot of land in the middle of some far-flung locale that may or may not — and generally not — have a significant resource underneath them. These companies go through significant promotional campaigns through stock promoters and brokers that are completely not aligned with their clients to push these stocks in front of them, and it’s a pretty sketchy little bracket that goes on up here. I’m pretty excited to shed some light on that. We do that in our other services, but I’m really excited to shed some light on that specifically to this audience and show them there’s a better way to actually invest in small-cap companies, instead of just speculating on pieces of land.
Hill: Tom, it’s interesting that you asked him that question, because there are a lot of investors who think of small caps, as a category, as being risky. Is that a fair perception?
Gardner: It depends on how we define risk. There are certain academic investors and research solutions that suggest that risk is about volatility. And in a way, that’s right. If stocks were to go down 50% and somebody would freak out and sell at that point, then that is some measure of risk. It means you can’t handle volatility. But in terms of the risk of losing money, long-term, small caps are generally the least risky. As long as you have that five to 10-year time horizon and get diversification, which Hidden Gems will be bringing, I believe that the long-term risk of Hidden Gems is lower than the market’s average risk, and certainly lower than the risk of large caps, a number of which will get disrupted by technology over the next 10 years. If you’re measuring risk by volatility, then yes, they are riskier. If volatility is just so much price movements on the way to your long-term outcome of investing in businesses, then no, I think they’re actually less risky.
Now, if they have stock promoters and brokers calling you on the phone at all hours of the day, and if you crack open their financials statement and there’s nothing there, those have tremendous risk. It’s not investing, it’s barely even speculating, it’s literally just lighting your money on fire.
Hill: David Kretzmann, how do limit orders fit into all of this? Why are they important when it comes to small-cap investing?
David Kretzmann: When you’re looking at market orders versus limit orders, first, with a market order, that’s when you’re buying in the open market, you’re putting in an order and saying, “I’m going to buy a share of Apple,” and you’ll immediately be matched with a seller at the best available price at that time. And market orders work pretty well with companies that have high volume, whether it’s Apple, Shopify, BlackBerry, companies that, on a daily basis, usually at least $1 million are exchanging hands each day. But with small caps, you’re dealing with much smaller companies with much thinner volume, or much lower volume, and there’s not a whole lot of action there. So, if you put in a market order, you might purchase shares at 15 or 20% above the last quoted price. So, with a limit order, you’re basically saying, “This is the maximum I’ll pay for this stock.”
A lot of times, when I’m buying a stock, I usually only use limit orders now, I’ve just gotten into the habit of doing that, and that’s certainly what we’re recommending incoming members of Hidden Gems Canada to do. Just use limit orders. It’ll avoid you a lot of pain. But, set limit order even 2-3% above the quoted price, be patient, wait for several days. Often times, if the stock does pop after a recommendation or a research report comes out, usually it’ll come back to earth. Obviously, we don’t want to squabble over pennies here, because the companies we’re recommending in Hidden Gems Canada we expect to recommend and hold for at least three years, ideally many years and decades. But we want to be sure that when members are starting their position, they’re not getting burned by going with a market order.
Hill: I mentioned at the top, you’ve worked alongside David Gardner for the last few years on services like Rule Breakers and Supernova. What are a couple of the things you’ve learned working with David?
Kretzmann: Well, he’s darn good at finding great companies early on. That’s the first thing, but that’s really just the beginning of being a great growth or small-cap investor. First, you do need that foresight to find great companies. But I think what really sets David apart from so many other investors is having the resilience to not only just hold those companies, but re-recommend them many times over the years. Obviously a great day for Netflix today. The stock popped 10% after another great earnings report from Netflix. Two of David’s recommendations of Netflix from 2004 and 2005 are up more than 10,000% now.
Gardner: More than 100X. $10,000 is $1 million 13 years later if you had bought and held Netflix.
Kretzmann: Yeah. Truly a game-changing investment. To his credit, David has recommended Netflix five times. He didn’t just recommend that once, unlike another brother here. [laughs]
Gardner: Thank you. That is true. I did get it into the Everlasting Portfolio a few more times, but —
Kretzmann: Yeah, you didn’t stick with one time.
Gardner: — it really is true. One of the great lessons from David is, although it’s contrary to human nature, add to your winners. They are winning businesses on average. It’s tempting to add to your losers because the price is cheaper now. But on average, when prices are getting cheaper and that’s running contrary to what’s happening to the rest of the market, that’s, on average, an indication that the business isn’t doing as well. So don’t fear rising prices. Actually seek them out, because they reflect a category of organizations that, on average, are getting stronger as businesses. It’s a great mindset shift for people.
Kretzmann: It’s a common theme with David’s recommendations through all of his services. Intuitive Surgical, one of the great performers in Rule Breakers, recommended six times. Baidu, another great performer, recommended three times. I think that’s something we’ll definitely try to bring to Hidden Gems Canada. As we featured with this launch bracket, we found 16 companies that we think have a lot of potential over the long-term, and I think a good chunk of these will make it into the service at some point, or certainly have that potential. But, finding those companies or recommending them once, hopefully that will just be the beginning, hopefully we’ll get a solid track of re-recommending companies. Because a couple other things that David will mention, along the lines of what Tom said, adding to your winners. Winners tend to keep on winning. Netflix, as it gets more momentum in the market, in that competitive marketplace, it attracts more subscribers, has a dynamic leadership team that not only started with DVD by mail subscriptions, which was a very unique business model at the time, it went into online streaming, then a few years later it started producing original content. So, those winners tend to keep on winning over a period of years and decades, which is our time horizon as investors.
Then, you often hear people, when they’re first getting into the market, you hear, “Buy low and sell high.” And David will say that his approach is to buy high and buy higher. And psychologically, that’s a very difficult thing for me and a lot of investors to wrap their minds around. But you see, many times, when he re-recommends a stock, it’s at a higher price than the first time he recommended it. But his great winning investments over time, that’s exactly what he’s done.
Gardner: I mean, historically, when was the time to not add to Starbucks? It has not been as great a stock over the last few years, although it’s been fine performer, certainly, it’s been a very solid performer. Go back to 1992, it’s up about 23% a year, which is unbelievable. Those returns are extraordinary. Again, type dollar amounts in and compound 23% a year for 25 years, it’s ridiculous what happens to somebody’s wealth. And again, so much of the financial media and the financial industry is focused on what’s happening in the next quarter. We were talking off camera before we started about Jeff Bezos and a really fun recent video interview in which he said, when Wall Street analysts say, “Great quarter, Jeff,” on the conference call, he’s thinking, “That’s funny, we actually had that baked in. We completed this quarter three years ago, we knew what was going to happen, because we’re acting and thinking so long term.”
So, for Jeff — interesting other factoid about Amazon that I think really applies to Hidden Gems investing — Jeff Bezos, I met the person who recruited half of Amazon’s board. And I asked him, what was the outlier factor that Jeff was looking for for board directors? And he said, Jeff demanded that no one join the board who would be concerned about where Amazon’s stock was within any period less than 10 years. And that is totally outrageous. They lost a lot of candidates because there are people going onto boards of public companies saying, “I could get sued, we have to watch the stock, that’s how we’re measuring your performance, Jeff. If the stock’s down over two years, you’re not doing a good job as CEO.” And Jeff said, “Great, you’re not on our board, because I’m not trying to be a CEO for the next couple years. I’m an owner trying to run the greatest organization I can over the next 10 to 25 years.” And when you find people like that, with that mentality, in the small-cap area, that’s where you find the 10-baggers, the 50-baggers, in Amazon’s case, the 400-baggers that totally transform our wealth.
Hill: Tom, you made a reference to the Everlasting Portfolio. We’ve been talking about David Gardner’s work in small-caps, but your work in small-caps is pretty fantastic as well with Hidden Gems, in Stock Advisor, in the Everlasting Portfolio. What are a couple of the things that you look for in small-caps when you’re looking for great investments?
Gardner: Sure. And I think there are a lot of Motley Fool investors that have done well in small-caps. Again, it’s the most attractive area long-term, so that shouldn’t surprise us. I certainly love to find a founder-run company. Founder-run businesses in the public markets out-perform the average return by about 2% a year. That’s incredible. Why is that happening? It’s harder than ever to run a company. There’s more transparency, pressure, short-term, all the rest. And when I find somebody like the CEO of Arista Networks, who technically isn’t a founder but essentially is, they’re thinking so far forward, they care so deeply. And they’ve made enough money, they could have left a long time ago, why are they still doing this? Well, they love what they’re doing. They believe in the mission of the organization. They care about the culture and the employees that are working there. And they have the reputation and a lot of their personal wealth on the line. So, I really love founder-run companies, and I certainly love high-growth businesses.
A lot of investors have a very hard time figuring out what the fair valuation is for a super high growth small-cap, because a lot of value investors can’t imagine that rate could continue, or something like it, for five or 10 or 15 years. But if we actually ran the numbers on what Netflix should have been valued at in 2004 to get a market’s average return, the multiple of sales would have been something so outrageous, nobody would have ever believed it. That’s why high-growth small-cap, and my belief, founder-run companies is a great universe to build a long-term investment portfolio around.
Hill: We’re going to get to some of the questions that have been coming in from our viewers.
Gardner: Hopefully we’ve got a lot of them.
Hill: First, and I’ll handle this one, question from one of the viewers–
Gardner: “Who is Chris Hill?”
Hill: [laughs] “Will I be able to read the transcript of this later this evening, since I won’t be able to watch it at 6PM?” Yes. We’re going to have a replay of this after we finish, and the transcript is going to be available sometime tomorrow. Iain, one of our viewers is asking, “Will the Hidden Gems Canada team be making regular quarterly comprehensive reports on each of the stocks that it recommends?”
Butler: We will. That’ll be similar to our other services, Stock Advisor Canada and Dividend Investor Canada. We’ll stick with that theme and, indeed, provide a synopsis. I mean, it’s not something that we spend a lot of time on, but we realize, especially with a smaller company, it’s nice to touch base and get a handle on where things are at. It’s unlikely to be anything that changes a thesis that we might have, but we’ll definitely be providing a review.
Kretzmann: And certainly, with our multimedia feature, one benefit of Canadian small-caps is, I think it’s easier for us as retail investors to access some of these management teams. So, as part of that multimedia feature, we’re hoping to bring in some executives and other members of these companies. That will be another way we can check in, in addition to the regular quarterly —
Gardner: Let me ask you about that, both of you, because certainly, I’ve encountered investors in my career who’ve said, “I don’t even want to talk to management, they’re going to sell me a marketing message about how everything’s amazing and I should buy their stock.” So, what are you actually looking for when you talk to an executive or an insider at one of these businesses that you’re considering for investment or have invested in?
Kretzmann: I can start with this, and then Iain, if you have anything else to add. But, I think it really goes along with what you just mentioned, Tom, focusing on culture, vision, and the long-term strategy that the company has, trying to get a sense for, is this manager or executive here for the long-term? Are they truly invested in the future of the business? Or are they really micromanaging on a quarterly level, trying to max out those shorter-term numbers? I think, meeting with executives like that can help us as retail investors get a better feel for the culture, the strategy and the vision of the company, than you might be able to pick up just from researching online and in the conference calls. But at the same time, you don’t want that to be the only factor that goes into your investing thesis. But, I think, as part of a well-rounded approach, it’s useful.
Butler: I’ll just jump in and say, I’ve had a lot of experience with management teams, and I would actually put myself in that camp where I’m skeptical of management teams. They just want to walk through a PowerPoint presentation and give you the sales pitch. I think where it comes in very handy in small-cap land is, certainly with the Venture Exchange listed companies, there’s a bit of a dearth of information. So, even to just get a background on the company is sometimes challenging. Fundamental information that you want to have in your back pocket can come through in those conversations. So, I think there’s certainly value in meetings. There’s a technical aspect, too, sometimes, with these companies, that’s the other thought that I had. Just to get their words on what the company actually does, sometimes it can be a little tricky, so, to gain a better understanding in layman’s terms can go a long way and help with the thesis as well.
Gardner: It’s funny, I’ve gotten to know an investor in Austin, Texas very well whose returns are completely out-of-this-world great, and he agrees with Motley Fool research that founder-run companies are a really attractive area to invest in. So, on his own initiative, he traveled around the U.S. and met with founders of, in most cases, very successful, like Gates, Zuckerberg, Bezos, he has an incredible network. He went through a set number of questions to try to figure out, why are these founders so successful? If the group of, let’s say, around 500 founder-run companies in the U.S. beat by 2% a year, that means the top 50 must be unbelievable and the bottom 100 are just below average or average. So, humorous thing that you can ask — there’s a more general way, which is to ask, what’s motivating you, why are you still doing this? Anyway, in his questioning of them, he has extracted from conversations that he believes many of the best founders of public companies that are still sitting in the CEO chair have at least one parent who doubted them.
Gardner: So, they feel this tremendous goal of trying to prove. And it’s funny, I’ve asked this of founder-CEOs directly, of some large companies. “Oh, that’s my mom.” “That’s Dad.” It’s funny. I think what’s driving the leader of that business, and if it’s looking like a professional manager managing quarterly earnings, trying to manage reputation rather than really trying to build something extraordinary and maybe convince people who doubt them, is a good motivator.
Kretzmann: We’ll have to remember that.
Hill: Got a question from Ken, who asks, “I think small caps are great idea. Iain, are there enough small caps in Canada outside of mining and resources to make this endeavor worthwhile?”
Butler: Absolutely. I don’t have the number at the tip of my fingers or the tip of my tongue. It’s not 1,000, it’s in the 600-700 range. We’ve done a screen in recent weeks. I believe there’s over 3,000 listings in the Canadian market, TSX and TSX Venture Exchange. A good number of those are not investable, so we throw those out. And I think it boils down to the 600-700 range. You can get a lot of traction on 600-700 companies. Not all of them are going to be great, but certainly there’s plenty of opportunity for big wins with that kind of pool to select from. That’s another reason why we’re offering the U.S. angle to this product. It’s going to open up significantly more ideas, significantly more opportunity, and I think combined, we’re looking at quite a massive pool of companies to select from.
Gardner: If we gave you a magic wand, Iain, and we said you could speak to one powerful government official in Canada about how to regulate the speculative garbage promotional companies, first of all, what would you ask them? And do you think there’s any possibility that that will ever happen? Because wouldn’t that possibly clear the path for different types of small companies to get funding and get more exposure?
Butler: I mean, the one thing I would say is, can we please have a national regulatory body? It’s a bit of a mess. Each province has their own regulatory body. There’s actually been a series of late in the Globe and Mail here of all the holes and cracks that exist in our system. So, I would request that they get on their soapbox and start preaching for a unified regulatory body that can seal up the ship, so to speak.
Hill: Before we go to David Kretzmann for the finalists of the fourth trend, Tom, we’ve gotten a couple of questions, I’m going to combine them, that speak to your sentiment in the market right now. There are people who look at, certainly in the U.S., a bull market that’s entering its, what, eighth year at this point? And they’re thinking, “Gosh, is it time to be on the sidelines? Is it time to take some of my money and put it on the sidelines?” How do you think about the market right now, particularly with respect to small-caps?
Gardner: One of the most important things about answering that question is to note how personal it is, or how much your situation matters. If that question came from a 14-year-old, I would say, “Just start buying great companies. The market will rise and fall. Use declines as an opportunity to add capital at discounted prices.” If you’re 81 years old and you’re living off your portfolio, obviously, then, at this point I think you want to lighten your exposure to equities based on certain factors, not just the performance but liquidity, the amount of capital sitting on the sidelines of markets versus where it was seven or eight or nine years ago, which was at extraordinary levels. So much money on the sidelines of the market in 2009. I think there’s a lot of personal factors that come into play there. But I would generally say, in my portfolio, the Everlasting Portfolio, we are right now at a pretty extraordinary level of 16% in cash. I think that’s a little bit extreme. I would say, having 5-10% of your portfolio in cash and making sure you have at least a five-year time horizon.
Last point I’ll add, because I know I’m in the way of the next level of stocks that you all believe in, I think so much comes down to time horizon. If you’re investing for the next 10 to 15 years, you should be adding every month. If you’re only invested for the next three years, you should be pulling back from equities. There’s a lot of data to show that time horizon is going to either render market levels irrelevant for you or very relevant. For us, the data shows at The Motley Fool, going back to 2002, when we launched Stock Advisor, and in 2003, Hidden Gems, that if we had never sold a stock all the way through, our returns would be better overall. And the mathematical reason is, every time you sell, like, one position of Netflix seven years ago, or one position of Amazon in 2006, you lose such upside in the portfolio that it doesn’t matter how well you sell in the other positions. So, really, I would say, hold onto your winners. Please add to your winners. But if you want to set some cash aside in the hopes that the market will decline at some point, I would understand that, as well.
Hill: Alright. David Kretzmann, the fourth emerging investment trend of 2018 Rule Breakers, do you want to take us to our two finalists from that quadrant?
Kretzmann: Yeah, let’s do it. Just a quick summary, the four companies in this Rule Breakers category that we have — and we’re kind of defining Rule Breakers here as a newer or emerging company taking a new approach to an older, established industry. So, not totally exact to the Rule Breakers service here in the U.S. but pulling some themes from that. First, we have AppFolio, which is a software company serving specific niche verticals or industries. Right now, they serve property managers and small law firms. Then, we have Redfin, which is a recent IPO in the U.S., just last year. Really an online real estate brokerage. Then we have Dorman Products, which is a company that makes products for the aftermarket of auto parts. They’re a big supplier to AutoZone, O’Reilly Auto Parts, those kinds of companies. Then we have Stamps.com, we have labeled as the Shopify of shipping. It’s a postage and shipping platform online, software platform where companies can manage all of their orders coming on from different marketplaces like Amazon or Shopify or Etsy, get those orders in one place and then find the best postage or shipping rates from there. So, our two finalists from this category: we have Redfin and Stamps.com moving on. So, one of those two will be one of our initial four recommendations in Hidden Gems Canada.
Hill: Back to the questions from our viewers. David, how will Hidden Gems differ from Rule Breakers?
Kretzmann: Well, we have Canadian companies. [laughs] So, that right there. I’d say, the specific focus on small-caps is something that you don’t see in Rule Breakers on the U.S. side. In the U.S., we’ve recommended companies well over $100 billion in market cap that still fit that Rule Breakers mold. And I’d say, actually, probably less than half of the companies that are recommended in Rule Breakers fit out criteria of small caps. Most of them tend to be bigger than $5 billion, just because in the U.S., a lot of companies are going public later, so they’re not going public at what we would necessarily consider a small-cap valuation. So, I would say those are the two main differences. We have the Canadian side, I think there’s a lot of untapped opportunity in the Canadian markets, so I’m excited personally to learn more about that market and find some of these companies that don’t get a whole lot of attention or aren’t in the limelight. And then, on the U.S. side, specifically focusing on some of these small-cap disruptors and innovators.
Gardner: One of the things I’ll say about those large companies that are in Rule Breakers and other services is, many of them are just such extraordinary businesses. They’re going to continue to reward shareholders, and they’re likely to continue to outperform the market’s average. But the chances of them providing a breakthrough return for your portfolio are very diminished if you’re a $100 billion market cap. Of course, we’ll have a $1 trillion market cap company here sometime soon, and we’ll have one that actually sustains it. But we’re not going to have many of them, first of all. So, $100 billion market cap, you should be thinking, “That’s moving into bond-like territory in terms of the returns I could expect over the next 10 years,” whereas the $3 billion market cap, if you found a great company like that, you could get a 10-bagger. And those are less rare.
Hill: Similar type of question, Iain, how does Hidden Gems differ from Discovery Canada?
Butler: Discovery Canada was a one-time portfolio offering. We provided allocations across the board to the collection that we provided and indicated that we were delivering all the intellectual property upfront. And we were going to maintain some communication over the first year, but the idea was for people to buy the portfolio and hold it for the five-year period. That’s what we did with The Motley Fool’s money, we put $200,000 behind it. And frankly, it was very much a buy-and-hold situation. It was small-cap focused, but the mandate was quite different. This is a more traditional subscription service, two ideas a month, similar to our other services, Stock Advisor Canada and Dividend Investor Canada.
Hill: We have a couple of industry-focused questions that I’ll get to in a second. But first Iain and then Tom, if you can weigh in — assuming a do it yourself investor never puts more than 5% in any one stock, what percentage of your portfolio should be in Hidden Gems?
Butler: It’s another one of these very personal questions, and it depends on a whole bunch of different variables, age being one of them, for sure. I’m not sure there’s a blanket answer for that one. If you’re on the younger side, early on in your investing career, certainly you can afford to have that percentage much higher. If you’re later stages, you probably want to be more allocated to the bond-like companies that Tom just mentioned. It depends on a lot of different things.
Gardner: Yeah. I would say, here are three key factors for anyone to really consider. What is my time horizon, when do I need this money? How much volatility can I emotionally handle? Like, if my portfolio is down 30% overall, is that going to crush my spirit, or is that just natural course and it’s fine, that’s the way it’s going to be? No. 3 would be, how much money can I be adding along the way? If you’re not able to add any more money, you have to think a little bit more strategically about your allocations. If you’re adding regularly, you know that if the market drops, you’ll be able to add in that period as well. And then the fourth is just your age. Putting those numbers together, I would say, let’s just say, anywhere between 5-25% of your portfolio could be in small caps. Those factors. I say 25%. If you’re 35 years old, you’re adding money every year — I mean, when we launched Hidden Gems, it was like, “Let’s build our portfolio around small caps.” So, I agree with Iain, it’s very personal. But those are some factors to consider.
Hill: “I would like to know if you’ve found a Hidden Gems investing in blockchain technology.” David Kretzmann, certainly, we’ve seen over the last few months, companies — some of them very legitimate, some of them about to go out of business, micro-caps, who just put out the press release saying, “Oh, we’re a blockchain company now,” and all of the sudden, their stock pops. Anything on your radar?
Gardner: Kodak comes to mind.
Kretzmann: [laughs] We’re not going to recommend Kodak.
Hill: Long Island Iced Tea.
Kretzmann: I’d say right now, within that whole crypto space, there’s a lot of speculation. I don’t see any pure play company that’s specifically focused on blockchain or crypto that’s public and very compelling at this point. You have some companies, like you mentioned, Long Island Iced Tea or Kodak, who I think are trying to ride the wave of this short-term momentum, where they put out a press release saying they’re somehow involved with cryptocurrency or blockchain, and the stock more than doubles in a day. That shows you there’s so much speculation —
Gardner: You know those celebrities in life that they say are well known for being well known, because when you look at their actual body of work, it’s like, I’m not even sure what they do. They were somewhere on reality TV, and they parlay that into this and that. And that’s what’s happening with those promotional companies. There’s a great Buffett line, “You won’t know who’s not wearing a bathing suit until the tide goes out.” And when the tide goes out on this market, you’re going to see a lot of crypto-like exposure that was just completely superficial.
Kretzmann: Yeah. I think you might see some companies that are in a better position to implement some of the underlying technology — everyone talks about blockchain or some of that technology — sooner than companies in other industries. I think particularly in finance, there’s some opportunities there. Iain can speak more to GMP Capital, which is almost a hidden beneficiary of this blockchain boom, because they help companies on the exchanges raise money and list. They’re not necessarily directly connected to this space, but they are a secondhand beneficiary, as they help other companies who maybe are more directly involved in the technology, and a little more speculative. They can benefit as those companies come to market.
Hill: Iain, do you want to jump in?
Butler: GMP is a picks-and-shovels way to get exposure. We’ve mentioned it as part of our collection, our bracket collection. Half the business is related to capital markets business, investment bank, helping companies come to the public markets. And they’re heavily allocated to the resource world. But this new emerging marijuana crypto-mania has spurred the investment bankers to look for fees in that area. So, I’m not sure. Frankly, I don’t know how morally right I feel about our attraction to the company, but it’s definitely taking advantage of the situation that’s evolving out there.
Gardner: It’s funny, because in many bubbles, a lot of speculative excess shows up in long-term trends. They’ve just jumped way ahead of the reality of today and the understanding of how it will play out. So, I think that’s very true. If you look at cryptocurrencies, here are some of the major long-term trends which we know: blockchain, absolutely. Digital assets in life. I think we should all be looking for businesses that are collecting and optimizing their digital assets. Companies that are saddled with physical assets and saddled with 20-year leases for retail locations in high-priced malls — I mean, there’s a lot of benefit to being flexible because you’re a digital company. Then, certainly, transactions and currency, and the idea — we can mock certain aspects of cryptocurrency, and I know we don’t all to an extreme level — but then, think of yourself being in a country where the currency is extremely unstable, and the idea of being able to move that to a global standard is going to be attractive, and to be able to do transactions in countries where it’s more difficult, with volatile currencies. So, there are major positive trends that we should continue to look at, and there will be great public companies and small-cap companies. It’s just that this has jumped ahead of the reality, and there really aren’t enough companies out there that have had time to grow up and become viable businesses and go public.
Kretzmann: Yeah. It’s certainly a category that it’s fascinating to follow, and a lot to learn. But I agree with you, Tom — right now, there’s just not a whole lot of legitimate public companies that have an underlying business or product yet. But I suspect that will come. But in the meantime, we don’t want FOMO — fear of missing out — to drive our investing decisions. Just because we’re worried that our neighbor is getting in on this crypto-craze, and they’re profiting a lot in the short-term, we don’t want that kind of urgency or desperation to be what pushes us into one investment or another.
Gardner: Totally agree.
Hill: Another question from one of our viewers: “One of the Hidden Gems, the Shopify of shipping, is trading at over $180 a share. Is it still a good deal, especially for those with not much money to invest?”
Kretzmann: Yeah. I would say, don’t focus on the share price. We’re focused on the value of the underlying business. The share price is really just a reflection of the total market value of the company divided by the total number of shares outstanding. Whether a stock is at $2 a share or $200 a share —
Gardner: One great example is, which would you rather have: 1,000 shares of Long Island Iced Tea — what’s the price of that, ballpark?
Kretzmann: It’s low. In the single digits, at least.
Gardner: So, 1,000 shares of Long Island Iced Tea, or one share of Berkshire Hathaway A, which is at about $320,000? So, in general, when you’re buying, the only reason the high share price could be negative for you is if you don’t have the amount of capital to buy one share or two shares and make the commission a tiny fraction of that. But, probably $180, it depends on where everyone is. If buying three or four shares of that right now is beyond a good allocation in your portfolio, I would see why you would pass that one. Otherwise it’s not a factor.
Kretzmann: Yeah. I would say, focus on the dollar amount invested, not necessarily the number of shares that you own. Then focus on, if I buy even one or two or 10 shares of this company, what percentage of my overall portfolio is it? I would base your investing decisions off of that, not just the share price of the stock.
Butler: If I could jump in, are there any theories, around the table, why this — it’s something that comes up all the time, and I’m continually baffled by the line of thinking.
Gardner: Why does that continue to be a question?
Butler: Is it a holdover from when people used to need to buy 100 shares in a block trade? What do people think is the genesis of that line of thought?
Gardner: Let me volunteer this one: we’re consumers, so, things that are of a higher price strike us as being, understandably, more expensive items that we’ll be buying in the marketplace. So, not only would we want a discount on something that we’re buying. If you found out, “Gosh, I could get a very similar phone for 40% less,” then, of course, you have to look at the features, the viability of that phone long-term, and other factors come in. But I think we’re naturally inclined to look for lower prices. So, when you get something that that $180, it’s like, “Wow, that’s a lot of money to put into a stock.”
Hill: And it’s not just that. If you think about the marketing messages, the commercial messages that are pushed to us online, through e-mail, on television, on the radio, wherever you’re consuming media, it’s all about discounting. And frankly, it’s attractive and pretty easy to look at — to go back to Long Island Iced Tea — a stock that’s trading at $1 and —
Gardner: Dream, and start dreaming.
Hill: — just thinking, “Gosh, all that has to do is go up $0.50 and I’ve made a 50% gain on my money.” Whereas, if you look at something at $180 a share, and you think in terms of, “Gosh, has to get to $360 for me to double my money?”
Gardner: And I know we all know this but, of course, the $180 stock on average has a much better chance of getting to $360 than the $1 to get to $1.50. And certainly, to do it sustainably — the other one might speculatively jump up there. But generally, stocks that are trading below $3 a share, not as a rule but generally, they are already bankrupt companies. They have very few assets and very little beyond a promotional scheme to get attention.
Hill: “Any interest in stocks dealing with lithium?” Iain, can I interest you in lithium?
Gardner: Why not?
Butler: It’s the textbook situation that we were speaking of earlier on the resource space. It has a great story behind it. Rechargeable batteries are obviously going to change the world, and this is a key ingredient. But every company that I’ve come across, there’s absolutely no financial track record there whatsoever, and if it’s not 100% it’s 99.8% promotional at this stage of the game.
Gardner: If I’m an investor and I don’t run my own valuations and I don’t read financial statements, I’m actually just reading the story, how do I distinguish between the lithium story and the Hidden Gems Canada small-cap story? What would be one or two things I might look for that indicate, this one here is pretty skimpy and this one looks like a solid opportunity?
Butler: From my standpoint, one example that comes to mind is, a lot of these junior resource companies are paying promotional companies to pump them up, write promotional things, blast them out and see what they can catch. I would say, scroll to the bottom of whatever you’re reading, and if there’s a disclaimer that says, “We’ve been paid by this company to produce this piece of work,” run.
Hill: [laughs] There’s your red flag.
Butler: That’s a 100% tell. Obviously, it’s something that we don’t do here at The Fool, because we have no association with any companies that we recommend. But, that’s as plain-Jane an example as I can think of where you just head for the hills as soon as you can — even, go to the disclaimer first, actually, and see if it’s there.
Hill: “Where do we see the futures in artificial intelligence technology going from here?” David, any AI stocks on your radar?
Kretzmann: Not pureplay AI companies on a small-cap level. Right now, you see a lot of the tech giants who are driving that space. Google doing a huge amount with AI and deep learning, fine-tuning these algorithms to an incredible degree, where a computer can translate and relay back multiple languages in a second or less, beating the best human players of Go with an algorithm. I think that’s where you want to focus to get a sense for where AI and those big tech trends are going. I certainly saw a lot of that at CES 2018 in Las Vegas a couple weeks ago with fellow Hidden Gems analyst, Taylor Muckerman. But, on a small-cap level, I have to say, I don’t see a lot of pureplay AI companies. I think there are some in the private space that might get snapped up pretty quickly before they have a chance to go public. But I don’t know, Tom, have you seen any?
Gardner: I’m going to echo your answer and just add these two things. Obviously, it’s likely that if artificial intelligence is going to play into the strength of your future as a business, that you were born and raised as a technology company. It’s going to be quite difficult to make a transition from hiring outside consultants to make technology decisions and not really knowing what your tech team does, to actually being a business that started on a technology platform and has been growing that way. That would be No. 1. It’s not a small cap anymore, but we interviewed Tobi Lütke at Shopify. And by the way, let me say, the only reason I recommended Shopify multiple times was because of our Motley Fool Canada event in Toronto when the analysts on the panel, and this was two years ago, Iain, was it?
Butler: That’s right. A year and a half.
Gardner: Okay, a year and a half, I have no sense of time. I need the AI calendar in my brain. A year and a half, every single one of the analysts on the panel, when I asked, “What’s your favorite stock right now,” they said Shopify. And I had actually never heard of it before. And I went back and researched it, and I was like, “Oh my gosh, what an unbelievable company and situation!” And one of my questions of Tobi was, “Do you foresee a day when Shopify, with algorithms, will allow me to simply type a dollar amount in, and Shopify will pick what business I go into and begin selling items, reporting back how I’m doing, and allow me to just tweak things like I’m playing a video game, essentially, but instead of it having no consequences, it’s a video game called the business you just created. You’re selling hand-knitted socks from XYZ, selling into this market and all the rest, and you just put money in and see how it goes.” And he said, “Our developers laugh about that all the time, because we do think that algorithms are where things are going. We’re already doing fraud detection with algorithms.” So, I think it’ll just proliferate, and I think a company like Shopify, no longer a small-cap, with a lot of AI research going on at universities in Ottawa and around, has a lot of access to a lot of talent and will benefit from that.
Kretzmann: And I think Netflix is a classic example of a company that, as you mentioned, Tom, has technology infused in what the company does. That allows them to almost seamlessly pivot from being a DVD company to an online streaming company to a company producing original content. I think looking at some of the companies on our launch bracket, you can see themes of that, where it’s not explicitly an AI company, but I see Redfin as a technology-powered or technology-based online real estate brokerage, trying to disrupt an industry that, up to this point, has been very fragmented. There’s not necessarily one go-to national player. So, I agree. I think that’s the lens you want to look at. You’re not necessarily going to find a pureplay “AI company.”
Hill: A couple of service-oriented questions I want to get to. First, Iain, “Will Canadian Hidden Gems be totally focused on Canada? Or will it be some overlap with the U.S. service?”
Butler: Again, there’s a Canadian and U.S. recommendation coming every month. We’re certainly going to leverage the recommendations out of U.S. services, certainly services that David is familiar with, certainly services that I have become familiar with. But, I think we have more of an open mandate to go outside those services if we want, and if we come across an interesting idea outside of (unclear 47:55), we’re certainly going to bring that to the table.
Hill: “What are the market caps on Hidden Gems, and will you be ranking buy, sell, hold, best buys now, similar to other services?”
Kretzmann: It looks like we lost Iain, so I can answer that for now. Right out of the gate, we won’t necessarily start with best buys now, because we won’t have more than four recommendations to start out with. But, every stock that is recommended and is on our scorecard is a buy, unless we mention otherwise, in which case it will be marked as hold. But, again, every stock that we recommend, every company that we bring into the service on the scorecard, we’re aiming to hold for at least three years. As Tom mentioned, our research at The Fool has shown that our results as investors would generally be a lot better if we hadn’t sold a stock. So, I think we’ll be very biased toward holding a company and giving it a chance over years, ideally. But, there will be cases where we want to put a company on hold and potentially completely part ways and sell. But, yeah, that will all be reflected on the scorecard. And we eventually will have best buys now, where we’ll probably highlight our top five ideas each month, in addition to the two new recommendations.
Gardner: One suggestion from me, and this is just a suggestion for members of Hidden Gems — well, first of all, I think you should become a member of Hidden Gems because I think it’s going to be a wonderful service, and I really look forward to seeing those results develop over five, 10, 15 years from the work of three great analysts and their teams and the community together. For being a small-cap investor going back 25 years now — The Motley Fool started in 1993, here we are in 2018 — I believe, particularly if you’re earlier on in your investment career, buy more stocks, not fewer. Not only will it tamp down some of the volatility, you will begin to see data that we show going back 25 years. Like, we’re right 60-70% of the time, we’re wrong 30-40% of the time. So, you don’t want to buy four stocks and hope that you’ve got the right ones. You want to diversify a portfolio. Next thing: negotiate your brokerage commissions down. It turns out, all these brokers, discount brokers, are actually negotiable. You could probably get 50 free trades from your existing discount broker right now just by calling and asking them and saying, “I’ve been looking around and considering some other offers.” You’re probably going to get that, and that will allow you to buy many stocks.
The final thing is, you will learn about a lot of different companies. We can get tunnel vision, and hope that one business that we have in the portfolio is better than it actually is because we have our money there, and it should just emerge, right, it’s going to eventually. If you have a diversified portfolio, you can accept the winners and losers, learn about a lot of situations, and learn which ones to add to over time, which, as we’ve said, is such a breakthrough for your outcomes long-term, if you’re learning about companies and going, “These four are so much better than these other 14 that I have. I’m going to keep adding to these ones.”
Hill: Question first for Iain, then Tom. “When you buy small caps, typically, how many years before you make any money or they’re worth selling?
Butler: We go into every idea with a three to five-year time horizon, and ideally, we’re going to love the company after five years as much as we do after five minutes — well, maybe not five minutes, but five hours, let’s call it — and we’ll want to continue that time horizon until we think differently. That’s our mentality going into most, maybe not all, I would say 95% of the companies that we look at, we go in with that mentality. Sometimes in the Canadian market, you deal with a cyclical company, and maybe you think you’re coming in at the bottom of a cycle and the cycle simply might not last three to five years, so you have to be a little more flexible on that front. But, that’s our typical time horizon, and I think that’s safe to say for most of our recommendations.
Gardner: Yeah, I think the fun thing about small caps, it depends how we define “make money,” but a great earnings announcement two months after you purchase could lead to almost a double of the value of that business. It happens. Would I bank things on that or want that to be the outcomes that I got from small-cap investing? No. But sort of the fun of the volatility of the stocks is, some of them will double in the first year. Of course, others of them will go down 30% after two weeks. There’s that pain and joy, the agony and the ecstasy of investing in small caps.
But, final point, it depends on we define “making money.” What I will say is, David, my older brother, has written about how transformed he was as an investor when he was given an account that our uncle managed for us as kids. And when that account arrived for him at age 25, that he now gets to manage, he looked and he was totally baffled. Now, this was back in the era of newspapers and fractional shares, not decimalization, online charts and graphs. And Dave got the account and looked, and one stock after another, the stock was at 58 and 7/8, and the cost basis was 1 and 3/8. And Dave thought, “How can that be for all these companies? I’ve never seen such a thing.” And then he realized, oh, they bought this stock in 1964, or they bought this stock in 1971, and now it’s 1986 or 1988 or 1984. So, it’s been given these 15 years to compound, and it’s a 30-bagger. And it’s not actually that unusual, if you do great business research, you get smarter as you go along and you have that long-term holding period. I really do think that 15-20 years. And if you’re sitting there thinking, “I don’t even know where I’ll be in 15-20 years,” I understand that. But your family will be beneficiaries of that long-term approach. So, I do think that the real money is made in small caps 5-20 years out, although you can certainly do quite well over a couple-year period with certain companies.
Hill: I’m going to handle the final question, which is, “Will there be any bundling of Canadian services at a cheaper cost?” No, there won’t. But with the discount I’m about to share, I think it’s going to feel like you’re getting an entire service for free. Again, it’s time to reveal our charter member pricing for Motley Fool Hidden Gems Canada. We have set the list price of Hidden Gems Canada at $499. But because this is our grand opening, I’m very excited to announce that we’ll be offering a special charter member discount that’s going to knock $200 off that list price for the duration of our grand opening period. That takes the price down to just $299 for one year of membership. That’s $0.82 a day for the charter membership of Hidden Gems Canada. I’ve also been told that if you join us within the first few days of the campaign, with our charter member lock-in pricing, you’ll actually be able to lock in that heavily discounted rate forever, even when we raise the price of Hidden Gems Canada in the near future, which is pretty much inevitable that we’re going to do at some point. I mean, right there, doesn’t that seem like kind of steal?
Gardner: I mean, if you love investing and you want business-focused research, not speculative resource companies, I think it’s a great offer.
Hill: Of course, with our 30-day full membership fee guarantee, you’ll be able to try out Hidden Gems Canada as a full-fledged charter member, including getting our four official starter stock recommendations the second you join. These are the four finalists in our top 16 small cap stocks to kick of 2018 bracket. You’ll have a front-row seat for the team’s first official Canadian small-cap recommendation, which comes out February 2nd. You’ll also be pulling out a front row seat for the team’s first official U.S. small cap recommendation, which comes out on February 16th. And then, just contact our team by day 30 for a full refund of the membership fee, just like that. Again, the only catch is that our grand opening period will only last a few days, and we will be closing the doors immediately once we reach 2,000 charter members, even if we do that on the first day. So, you’ll definitely want to keep an eye out for your private charter member invitation, which is going to be arriving tomorrow morning in your inbox. Until then, thank you so much for joining us. Thank you to David Kretzmann, Iain Butler, and —
Gardner: Can I make a special announcement, Chris?
Hill: Absolutely. Tom Gardner.
Gardner: I literally, through the magic of the internet, combined with the application called Slack, which I know many of you are familiar with, I was able to Slack our Canada team and ask — and this really is real time, this isn’t like, “Wow, I’m sure this was staged,” that I would love to add into the service to members joining us in Hidden Gems, my two favorite U.S. small caps at the time of your arrival into the service. Now, I don’t mean to say that my two are going to be any better than the beauty that’s happening already in this event and experience for you in narrowing the 16 down to four down to two down to one. But, I think I have two companies that I really love long-term, so we’ll add those in as well.
Hill: A last-second bonus! That’s a little something we like to call the CEO prerogative.
Kretzmann: Fair game.
Gardner: [laughs] Also, I would like to boost my compensation by one free meal. Okay! If only I had that type of authority at our company. The beauty of The Motley Fool, truly, if, for example, this is your first event that you’ve ever experienced with us, you may have gotten a sense from Iain, David and Chris, we have so many bright, dedicated people who share our purpose of helping the world invest better, helping you invest better, not for the next three months but for the next five, 10, 15 years, for your kids, your grandkids, to make smart decisions about money and investment. So, yeah, the CEO at The Motley Fool is really just one person who gets to learn from so many smart people over the last 25 years, and excited about the next 25 years.
Hill: That’s a great way to wrap up. All right, David Kretzmann, Iain Butler, Tom Gardner, thank you so much for taking the time to join us tonight! Check your e-mail tomorrow morning for that invitation, and Fool on!