If I was going to manage money for investors (i.e. be a fund manager) I’d probably only do it if I could invest in small-cap ASX shares… and private companies.
That is, companies below $500 million in market value.
There is where I think the best opportunities lay for thick-skinned, long-term, focused, high conviction investors.
However, there’s one big problem with ASX-listed small-caps…
There aren’t that many good companies to invest in.
By the time you focus on only those companies with under $100 million in revenue — and exclude mining and resources shares — there are less than 400 companies available.
And between $5 million and $10 million of revenue — there are only ~70! That’s according to NAOS Asset Management, which is the latest guest on our investors podcast series. It’s free to subscribe on iTunes, Google or Spotify.
(It’s a great interview for growth-style investors, check it out!)
However, if we look outside the ASX we’ll find there are nearly 50,000 companies operating in Australia with $2 million or more in revenue.
Family businesses, technology businesses, start-ups, education, healthcare… you name it. Put simply, there are a lot more potential opportunities.
No doubt many of these companies would be shocking investments.
Like those ‘business in a box’ style operations.
You know the type: coffee or fast food franchises, retail shops with outrageous leases and product branding fees, etc.
Indeed, if you venture out into the world of ‘private business investing’ you will definitely have to work harder to find solid opportunities.
You’ll have to keep your wits about you.
Unlike on the ASX, where everything is audited by experts and analysts scour the accounts, investing in small businesses, like your local mechanic or restaurant, involves combing through bank statements, loan documents, shareholder agreements, important contracts, and so on.
However…
All that said, if I were a fund manager, managing my own money, plus that of my friends, family and the faithful, I’d strongly consider a mixture of private and public (ASX-listed small-cap) companies.
This is how Warren Buffett & Charlie Munger made their name. They take big chunks of private or public companies and let their managers do great work.
It’s the same approach at Australia’s own Washington H. Soul Pattinson (ASX: SOL). They have a private and public investment portfolio, wrapped inside an ASX-listed company structure.
Meaning, you can trade your Soul Patts shares without the company’s investments in private companies being impacted by shareholders selling out.
Again, there are big risks to private company investing — which is why there are so few fund managers in the market.
And many of the firms who do offer this type of investing (private equity companies) charge extremely high fees and do whatever they can to ‘squeeze’ the life out of private businesses.
So much so that sometimes the business can go bust from the financial pressure put onto it by their new investment banking owners.
1 hack to invest better
To be clear, I’m not saying everyone should invest in a private company as I have (my company, Rask, is private). It’s risky. Say goodbye to your hair — and your spare time.
And if you ask me, private company investing should be considered a 10-year commitment.
However, I believe a great way to ‘invest like a business owner’ is simply to jump online and explore all the different types of private businesses someone can buy and sell.
It’s revealing…
I recently did this activity with the Rask analyst team, asking them what they would pay for a Sushi shop that was for sale in Cairns.
1 x annual revenue?
2 x annual revenue?
3 x annual revenue?
“Who doesn’t love fresh sushi!”
Clearly, my analyst team.
I’ll summarise their answer to my question: “not very much.”
Few investors know this but Seek Business includes listings of private businesses (Red Rooster franchises, Laundromats, cafes, restaurants, construction businesses, etc.) all across Australia.
Sure, many of them would probably be horrible businesses to own and may even be on the verge of going bust. So that’s perhaps why Seek provides an 8-point guide to help new business owners and investors.
But it’s still a good exercise to see what’s available.
The one thing you need to know is this…
Many investors on the stock market forget that shares are just part ownership of real businesses. Yes, share prices can jump up and down due to scary news headlines or investor psychology.
But if you wanted to buy a local business, would you really try to ‘trade the price’ of the business day-to-day?
Would you ‘dabble’ in owning a private McDonald’s franchise?
Would you panic if a slimy bloke walked up to you tomorrow and said, “Hey, your business is worth 5% less today — wanna sell it cheap”?
And would you really buy a local business today with the aim of selling it in a few months?
I highly doubt it.
Successful long-term stock market investing works because you buy good businesses and let them do the growing for you.
Therefore, to benefit from the true power of the stock market, think more like a local business owner and less like an “analyst”.
I reckon your future self will thank you for it.
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