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Podcast - Small Cap Stocks

Stefan Angelini is Joined by Paul Biddle from Celeste Funds Management to discuss investing into Australian Small Caps, or smaller companies.


Stefan Angelini

We are on. Hey there, welcome to another episode of investor types. What we're talking about today is investing into Australian small cap investments or small cap stocks. typically not your big names that you might see on the side of buildings, you typically use smaller names, but it's still very well renowned around Australia and who I'm talking with today. I'm talking to Paul Biddle from Solace Fund Management funds management. Paul, thanks for coming on mate.


Paul Biddle

My pleasure, mate.


Stefan Angelini

What do I know headed a country boy like yourself and up in the Big Smoke in Sydney now running a fund manager that invest hundreds of millions of dollars of people's money?


Paul Biddle

Yeah. I'd say I'd say look, I mean, as an eight year old, I wash trays in the back of my dad's butcher shop. So you know, from the country, third generation, butcher are going accounting degree and I came to the city to get an accounting degree and I met my wife is also from the country and we never went on. And I really, I grew up in an environment where we never had a lot.


Stefan Angelini

Yeah.


Paul Biddle

So for me, protecting money was a really important component of of of what you needed to do if you want to grow wealth. And so naturally, I kind of fell into finance and finance related roles and, you know, as a stockbroker for a wall and then literally for the last 20 years, I've been a fund manager, looking at that sort of more exciting in the small cap market, which is, you know, we think about it as the big anything. Nab and Rio Tinto and bhp.


Stefan Angelini

Yeap.


Paul Biddle

And that's the top hundred companies in Australia. We look at the companies under the top hundred. So when you think about it, size wise, that's probably about three 3.5 billion, which is still a big number of market cap.


Stefan Angelini

Yeah.


Paul Biddle

But it goes all the way down to the little guys down into 100 200 300 million. And it's it's quite an exciting place. It's a it's still a bit wild west. But But yeah, it's fun.


Stefan Angelini

That's a big gap. 3.5 billion to 100 million less than 100 million.


Paul Biddle

Yeah,


Stefan Angelini

so that's a market capitalization. Could you tell us how do you work at market capitalization And what is it?


Paul Biddle

Yeah, market capitalization is used to essentially describe size. And I think about it like this. Let's say you and I had a business, and it was a construction business


Stefan Angelini

Yeap.


Paul Biddle

and you have a share I have a share. And let's say the shares traded a dollar age. Well, you take the 1 dollar share price, we've got two shares, you multiply it by the share price to the value of two. Let's say the share price goes up to 10. Well, you've got a share and I've got a share. So we've got two shares, we multiply it by two divided 10. And it's, it's 20 bucks.


Stefan Angelini

Yeap. That's right.


Paul Biddle

So when you think about when people look at share prices, they go on the share price is eighty dollars must be expensive. That's not the way to think about and what you say is, well, how many shares are on issue because it was only one share on issue and eighty dollars. It's only valued at eighty.


Stefan Angelini

Yeah.


Paul Biddle

If there's a million shares on issue, and eighty dollars, it's worth eighty million.


Stefan Angelini

Yeah.


Paul Biddle

So share prices are a guide you've size, you need to know how many shares are on issue, multiply that by the share price. And that gives you the market capitalization. So, that's that's a good way to to to think about size and opportunity. Because you know that the banks are over $200 billion of market


Stefan Angelini

Yeap.


Paul Biddle

Capitalization. So a 100 million dollars is really a small company.


Stefan Angelini

Yeah.


Paul Biddle

And and the opportunity in the smaller companies exists because viral grow earnings faster than big caps. They have the opportunities for growth that big caps don't have an in small The wonderful thing is, if you think about the big cap market, there's four big banks. There's a big telco. There's a big infrastructure stope


Stefan Angelini

Yeah,


Paul Biddle

There's there's two resource companies.


Stefan Angelini

Yeah,


Paul Biddle

If you add up the top 12 stocks in the Ozzy market, it's 50% of the index top 12 stocks make up 50% of the top hundred. So you don't have any diversity


Stefan Angelini

No.


Paul Biddle

Right? If you do that for smalls, the top 12 makeup seven, nine. So the opportunity set to have the ability to invest in industries that don't exist in the top end detail. You have unique opportunities to invest in small cap companies that are growing that have products that don't exist. And the example there is, if you want to run a company that has exposure to billing systems, you can't do that that's not in the top hundred now. But there's still cool hands in the in the small cap market. If you want exposure to financial transactions, and you think well I want to learn the banks. You can invest in the small smaller cap stocks. I'm going to talk a little bit about big multiple stocks versus smalls. But a really great stock that can invest in the financial services spaces if you think about you go last year you may everyone here in Australia had threatened 35 transactions that were electronic were you beach card.


Stefan Angelini

Yeap.


Paul Biddle

70% of transactions are our joint. So that means good old school cash is still 30%.


Stefan Angelini

Yeah.


Paul Biddle

But if you think about


Stefan Angelini

Still


Paul Biddle

Still yeah. Yeah


Stefan Angelini

Right.


Paul Biddle

Yeah yeah so, but if you think about it, 30 is getting out of five, something like that. So everyone's gonna beat the card more, everyone's going to do a lot more electronic transactions. You don't have to pick the winner, whether it be MasterCard, Visa card, Afterpay, ZipMoney. You step back from that and you go, who will give me exposure to just transaction processing was a great company with a market cap of $500 million, hundred million dollars where the revenue $20 million with earnings. It's called integrated research stock RO ROI. So it's got this massive tailwind of people beeping more, and I charge pervade to people like the systems run on. Let's get through thrown Woolies Calls NAB, ANZ, Telstra, JPMorgan, Barclays, Visa, MasterCard, you know,


Stefan Angelini

Yeah. So these are the companies that you might see as the up and comers. They generally haven't been around for 50 hundred years. But they got new technology that's adapting with the times where you'd expect massive revenue growth and good profit growth.


Paul Biddle

Yeap.


Stefan Angelini

Provided they're managed well


Paul Biddle

Correct.


Stefan Angelini

And they are actually a good company.


Paul Biddle

But being a small cap doesn't mean it's just started. I mean, the thing about small caps is, these are names that you would you would think about and and no. Breville, the small electrical appliance has been in the portfolio for 15 years. ROI the integrated research we just spoke about started in 1999. They no fly by night, just gotten started.


Stefan Angelini

Yeap.


Paul Biddle

Take companies that fell out of some way that we go great. This is an opportunity by it. They are long duration companies, IRB been manufacturing four wheel drive parts since the 70s. You know, these are high quality industrial businesses that have good management, good board, great runway of opportunity to grow and will always grow faster than the big cap space.


Stefan Angelini

Yeah, it was you got you got so many different industries you look at.


Paul Biddle

Yeah.


Stefan Angelini

And when you assess a company, I guess a lot of people when they start investing into stocks, they focus on these companies, these maybe up and comers that are good quality businesses that are too expensive where they can buy a share for between $5 and $30.


Paul Biddle

Yeah. Yeah.


Stefan Angelini

And what do you see is the three main fundamentals that you look at when you are buying a company


Paul Biddle

Yeap.


Stefan Angelini

And wanting to invest your money into the small cap companies?


Paul Biddle

Yeah, yeah. And that's a great point, because you shouldn't listen to what you might tells you at the pub


Stefan Angelini

Night


Paul Biddle

Or the cab


Stefan Angelini

I’ve made that mistake. Cab drivers are smart.


Paul Biddle

Depending on how light it is.


Paul Biddle

But but the key things that we think about and we think about it like a stool, you should always think about it like a stool. If a stool doesn't have three legs, falls out, so like investment. If it doesn't have the three things that you know, falls are done by it, alright. You might speculate in it and put 10 bucks that you prepared to lose in. That's different to investing investing is creating long term wealth that is sustainable, that you passed down to generations and that is investing we think about like this board and management, you look at the board and the management, you look at the board first, because the board, appoint the management, the board, pay the management and the board hold management accountable to the strategy. And then you look at the management, and you say, are they capable and able to run this business? Have they run businesses in the past where I have been truthful, executed on the strategy and delivered for investors?


Stefan Angelini

Yeah,


Paul Biddle

People are volatile, because the fish rots from the head. And if there is a culture and the people aren't right, don't invest. Then we look at the accounts. So we look at the accounts the the P and L, sorry, profit loss, the balance sheet and the cash flow. And we look at the accounts because the accounts have to be constructed in either conservative or aggressive manner when we look at them, because you can when you toss a coin never falls on a stage alright. Its heads on top. They're is a conservative or they're aggressive. We want to buy stocks that have got conservative accounts, where they have assets on land and buildings on balance sheet, where they have conservative assumptions about the asset values where they convert a lot of cash to what we call the good guys, the shareholders were there. And so you want to look at the accounts and you want to understand them. And then, and if that leg doesn't stand in the management of great don't invest,


Stefan Angelini

Yeah.


Paul Biddle

Because that's another bottle like the third is, ultimately you got to understand the industry.


Stefan Angelini

Yeah.


Paul Biddle

And part of that is, as humans, we all think we can understand everything. You've got to know your limitations. And you've got to look at the industry. And you got to understand, will least produce long term durable, sustainable cash flows. One of the volatilities that happened in that industry, what are the competitors? Like? What will what will happen in terms of pricing? And one of the things that I don't know and I think it's really vital because when you buy the share, a lot of people will talk about what PE, which is that, for example, and a PE is what's called a price to earnings. So if you think about it like this, if the price is a dollar, and the company earns 10 cents a share worth of earnings, and it's a dollar divided by 10 cents so the PE is 10. So if you, the higher the PE, traditionally, the more expensive the stock is deemed to be.


Stefan Angelini

Yeah.


Paul Biddle

But if I think about it a different way, if I say to you, you're going to pay a PE of 10, that means that you think you understand what the industry will be like, for the next 10 years, because you're hoping that company makes 10 cents a year or more for the next 10 years for you to get your money back.


Stefan Angelini

Yeah.


Paul Biddle

So if you pay a PE of 20, you're saying I think I know what the industry will look like in 20 years. So the higher the PE the more Expensive the stock is, the more you have to have a crystal ball and look to the industry and understand what it might be


Stefan Angelini

Try and predict where they're going to get their growth from because they're on the way to reduce that is to make more profit, more earnings.

Paul Biddle

Correct. So they might grow earnings. And actually what you might find is that in 70s, you get you money back, but


Stefan Angelini

Yeap.


Paul Biddle

70s is still a long time. That's your child going for me 78 12 and first year unit.


Stefan Angelini

Yeah.


Paul Biddle

Right.


Stefan Angelini

Twenty five


Paul Biddle

Long term this big to this big . Yeah, I'm still asking for money, but you know. So, what we try and do is if you understand the nature of the industry, and you look at the accounts and see whether the accounts reflect what you are seeing in the industry, and the cash conversion, and the management and the board of good. You've got three legs to still


Stefan Angelini

Yeap


Paul Biddle

Still stand. And then the last piece to the puzzle is, what is it worth but we don't get to what is


Stefan Angelini

Yeah


Paul Biddle

Worth unless the three legs exist, the three key points and then they we go, okay thinking what we know about the industry, thinking about the management and the execution and the strategy and where they're going to take the business. What could this be worth and how do we value it?


Stefan Angelini

But I think that knowing the industry part is such a volatile point because you get these market darlings that come up these names that everyone talk about, that have essentially shut up in stock price. So people made a lot of money.


Paul Biddle

Yeah. Yeah.


Stefan Angelini

But then you get these people that might work in the construction space and start investing in a financial tech company.


Paul Biddle

Yeap.


Stefan Angelini

And they think they're gonna make a lot of money. But then there's a lot of volatility and they're playing these enormous prices.


Paul Biddle

Yeah


Stefan Angelini

A high PE multiple.


Paul Biddle

Yeah


Stefan Angelini

That means, as you said, they're expecting profit to remain the same for the next 20 30 40 50 years.


Paul Biddle

yeah.


Stefan Angelini

What do you see the difference between, I guess these market darlings and these secure secure companies that are trading on high multiples?


Paul Biddle

Yeah, I look. Again, it goes back to my capital protection mentality and look at in grinding in who I am, but I like to buy companies where I believe there is a reasonable evaluation. Where the business has earnings? Sorry, generates revenues, has a containable cost buys and makes a profit.


Stefan Angelini

Yeah.


Paul Biddle

The profit converts to cash, the cash pays a dividend.


Stefan Angelini

Yeah.


Paul Biddle

Because at the end of the day, that's all that matters. Cash matters,


Stefan Angelini

That's right?


Paul Biddle

And so if ever, as an investor, I'm getting a dividend stream on generating a yield, because they pay tax, you're getting a franking component.


Stefan Angelini

Yeap.


Paul Biddle

So I'm getting a return to on that stock.


Stefan Angelini

Yeah. It really is a long term approach, isn't it?


Paul Biddle

Absolutely.


Stefan Angelini

Yeah.


Paul Biddle

And then what you do is you want to want a company that can grow revenues, contain its cost base and make more money than it did last year and then your dividend will grow. But equally, the share price will grow because that company is making more money than it used to. And the share price is higher. So you get your dividend yield is grossed up for franking. You get a capital component and you're making an annualized return and that works for investors who are new to the game because I can take the cash flow and reinvest into other stocks and create more wealth. It works for retirees who have want an income stream to live on? And so, as an investor, that's what I want?


Stefan Angelini

Yeap.


Paul Biddle

If I buy it a stock, that's conceptual in nature, startup losing money growing market share, trying to achieve market penetration, I've got some risks. The risk is I don't know what the industry is. And if the PE we talked about before is, say, 50. That means that I would need to understand what I think the industry will be today to when I turn 100. Okay,


Stefan Angelini

yeah.


Paul Biddle

So that's the context you need to think about, but in between for the next five, possibly 10 years. It didn’t making any money. So that that I spoke about where the revenue through cost becomes profit and cash, and I get a dividend, you don't get that.


Stefan Angelini

Yeah.


Paul Biddle

So what you get is you get a punt, on what the industry might look like later in the future. And that's risky.


Stefan Angelini

Yeah.


Paul Biddle

You know, and and it's a little like you think about it as if the PE of 50 falls to 30. Okay, you've lost 40% of your money.


Stefan Angelini

That's a lot of money.


Paul Biddle

Right?


Stefan Angelini

Yeah.


Paul Biddle

And then I never coming back. Right? And so, because someone says, Oh, it's worth 50 why can't someone says worth 40? And what's happened is, it started out at 20. And everyone went, Oh my goodness, this is this is the greatest thing since finance, like after pay is a great example.


Stefan Angelini

Yeah


Paul Biddle

It started greatest things in finance, it's going to revolutionize the industry. It's actually a really good product. So some of these companies have good products.


Stefan Angelini

Yeah.


Paul Biddle

But it goes back to what do you pay? And I would always use that term. When you go into a cake shop. You look in the window, and you think that is a nice cake. And then you say, Well, what do you say? You say what does it cost? How much is that cake? Right? You don't go that's a nice cake. I'll have it.


Stefan Angelini

Oh comes at a cost.


Paul Biddle

Hundred percent.


Stefan Angelini

Yeap,


Paul Biddle

You've gotta ask, How much am I paying for high PE stocks? And what is the risk? And I think that's really important because some, you've got to be very careful that you don't just get on the bandwagon and more on the stocks because a lot of people have made money out of it. You need to remember that long term wealth is created out of capital preservation.


Stefan Angelini

Yeah.


Paul Biddle

So if you lose your capital, it's really hard to get back. And it's difficult and you've got to then invest again and start and build that wealth back to where it was, before you starting grow it.


Stefan Angelini

I love that says it's not always about the price just because the price is going up doesn't mean it will continue to run much likely, it won't continue to run. So when you look at the fundamentals, you look at the reports, you understand the industry


Paul Biddle

Yeap.


Stefan Angelini

And as I said before, someone that's in the construction or property space, investing in a financial tech company might not be right. But let's say someone in the construction and tech space, or the construction and property space.


Paul Biddle

Yeah.


Stefan Angelini

Why invest into a company. That's in that space. They understand.


Paul Biddle

Yeah.


Stefan Angelini

So let's look at a company like REECE. Have you done any due diligence on REECE? And what do you believe to be the company?


Paul Biddle

All REECE? Actually since the strategy and Celeste has been running for 15 years.


Stefan Angelini

Yeah.


Paul Biddle

I cannot be near 15 years and and, and REECE has been in our portfolio the whole fifteen years.


Stefan Angelini

Right.


Paul Biddle

And REECE continues to be an important part of our portfolio. I think the thing is tangible, viable. Businesses can continue to find ways to grow REECEs, a fantastic business REECEs 70 plus percent owned by the Wilson family here in Melbourne. They have created significant long term wealth over those years. They have taylor their business to target the construction industry to be absolutely best in class than a vast bulk of their of their of the resorts you see


Stefan Angelini

On the land as well as operate the business


Paul Biddle

On the land operate the business. They've been really innovative. In terms of putting in front of shop really innovative design centers to actually bring to market products that they manufacture themselves along with key suppliers but actually giving the plumber the capability to be able to pick up at back of shop everything they need like a couple of deliveries that they decide and this is something that somebody in the construction industry would go a lot guys go so I get all the stuff they're they're easy to deal with their own lawn I can order online and get my bills paid online. I got a saying that the client ran to the front side what is it you want? What is it like can makes more life easier


Stefan Angelini

But my business used to buy from China now they've come back to buying from REECE?


Paul Biddle

Yeah. Yeah.


Stefan Angelini

You can see that happening.


Paul Biddle

Yeah. And And the thing about it is, it's about life. Life is about relationships.


Stefan Angelini

Yeah.


Paul Biddle

Life is about having trusted relationships with people who you believe will help you add value to your life make your life easier. REECE is one of those counterparties where you know I love it. I wonder around and I say REECE makes small off easier REECE you know, don't don't trust a non licensed plumber.


Stefan Angelini

Yeah.


Paul Biddle

You know I love that my kids drive by and like dad, there's another Reece that I'm gonna work.


Stefan Angelini

Yeah


Paul Biddle

That is a businesses it's been built on service and delivery and 450 plus stores around Australia and they've crushed their competitors because they competitors have been big organizations that have had multiple different business lines and and plumbing and plumbing, tried supplies, refrigeration, HVAC have been a secondary part. Where the Wilsons are co investors, you're investing with the Wilson family.


Stefan Angelini

Right. So when you're investing with a family, and that's where most of their money is, you expect them to do well. And that comes down to their management team.


Paul Biddle

Yeap.


Stefan Angelini

They're going to implement the right management team and this is any business in small caps that you want to invest in and getting to know managers of different funds is is hard.


Paul Biddle

Yeah.


Stefan Angelini

It's not publicly available knowledge or you can look at where they work and what they did and if they blow company up or not but even understanding their trajectory for Future you can read the company reports all you want.


Paul Biddle

Yeah.


Stefan Angelini

But unless you're going and speaking to these people you get, then you get to really understand who they are, what they do what they want to do.


Paul Biddle

Yeah.


Stefan Angelini

So when it comes down to assessing the management of company, how important is it? And how do you do it? Because I know, you go pretty full on when you ask these questions, and you start to really analyze what they're doing. And I love chatting to your bed. So how do you do it? What what do you do when you talk to management of companies?


Paul Biddle

Yeah. Look, again, it's all about, I believe, sitting and asking reasonable and fair questions and seeing what the responses


Stefan Angelini

Yeah.


Paul Biddle

This is a very different response. If you ask me a question to a question where I'm happy to talk to you and explain things. The body language is important.


Stefan Angelini

Yeah.


Paul Biddle

But I think trying to understand, and I would argue, how did how do you get paid? What is your objective? And what do you think he can do? They're important questions, because that will tell me, where do you think the business can be one of the opportunities, one of the risks because ultimately, everybody has been bills to pay and kids go to school and and so people want to get paid well for what they do. So asking questions around the remuneration, how that works, what you get rewarded for, but I think it's also asking legitimate questions about their business, how they run their business, what they see is the risks, one of the opportunities. And this is stuff that that, and you're right, it's not that the information is non public, and it's inside information. It's information where you're helping me to understand your business better, so that I can then put your business in the context of understanding the industry, understanding your competitors and seeing where the opportunities are. And, and I think it's important we don't only just chat to the CEO, we check to the CFO, which is the chief financial officer. We try to check the people further in the business. So it might be a state manager, it might be when I go to raise when my wife is trying to buy a bathtub. I sat down and chatted to the lady and said you know how things what are you doing? Like, I think Frank had a plumber come to his house. So we followed him around a little bit nasty stuff from


Stefan Angelini

Yeah,


Paul Biddle

So we're always researching a company or companies we own or opportunities because that's, that's vital. We just, we leave investing. We also chat the boards, we chat non executive directors, we chat the chairman, we chat to them with the reason of asking how do you see the strategy? This is how to use the the strategy is what you're telling me what you're telling me? And is there 80 percent commonality? And if there's 20 different he, where's the difference? And is that going to cause me a problem? Do you think you get paid fairly? Do you think you pay him fairly? Because so much of the interaction is people, companies that just an aggregation of people trying to achieve an outcome? So you've got to remember people have different biases. You know, you might have seen how these things are. I can do no wrong on the best person in the world. That generally is a bit of a risk.


Stefan Angelini

Yeap.


Paul Biddle

You know, you might have a CEO who's very quiet and understated. And she says, You know, I think I can execute on the process and smashes it. That's a great CEO they have, but they're probably pretty quiet. And the share price might not reflect the value in that company for a period of time. So it's about understanding the people. It's about understanding the business. And it's about asking questions, which I'm really good at. Why, why why did why does that happen?


Stefan Angelini

Yes,


Paul Biddle

Cause.


Stefan Angelini

There must be hack when you do that.


Paul Biddle

I think there's a healthy respect.


Stefan Angelini

Yeah.