Buffett literally said he’d earn 50% returns if he only had $1 million to manage.
This idea clicked for me two years ago. I was attending a conference at Harvard where Seth Klarman spoke. And I remember him saying something like “small caps (<$500M) are one of the few places left to find asymmetric returns.”
Then I realized it’s what Buffett had done for as long as he could, and what Munger suggested to start. Greenblatt had followed this path at Gotham and Graham wrote there might be a lesson in his Geico purchase.
The smartest and most successful investors all agreed on this. Though I formerly held a different view, I thought it deserved careful analysis.
Now it seems obvious.
$20 bills aren’t lying around on Fifth Avenue. The market is not stupid.
You might find them, however, in streets few people visit.
Investing is about paying $50 for something that’s worth $100. It’s about finding $20 bills no one has picked up yet.
You choose the game’s difficulty. Why would you go fish in a lake which has a few fish and compete with very talented fishermen? Look for a pond no one’s fishing in. You don’t earn extra points for complexity.
Mispricing occurs when: (1) there’s very little public information; (2) players are not sophisticated; (3) there’s very few players; (4) the media manipulates people; (5) cycles + other reasons.
Frequent transactions of an asset lead to more efficient pricing, most of the time. Market prices follow intrinsic values, and they converge as more and more investors get a better grasp of the underlying business.
The stock market is not like democracy - the more capital you put behind a market order, the more you influence the asset’s price. And because capital tends toward sophisticated hands, more transactions typically lead to better pricing.
When there’s not much capital after a stock (<$50M), anyone can cast a huge vote. A $10,000 market order can swipe through the whole order book. A fat finger can send the stock 30% down searching for buyers. More people, sophisticated or not, have disproportionate influence over these assets.
It’s in small caps where you can find great businesses, growing 20%+ while trading at <10x earnings, oftentimes <5x.
Truly good investors grow out of this pond and institutions can’t access them because of market cap requirements. All of these create the perfect conditions for systematic mispricings to occur.