Wager Value

Wager Value

Hit em where they ain’t

Willie Keeler

Back in the eighties I use to go to the racetrack to bet on Thoroughbred Racehorses. It was a good training ground for investing in the stock market. I came across a term by handicapping author,  James Cramer. He called it Wager Value.  Essentially it meant focusing on information that other handicappers weren’t using. Whereas most people who went to the track used speed ratings and the horse’s current form shown in the past performance tables, Cramer like Stephen Davidowitz before him focused on trainer patterns, track bias and result charts. He reasoned that if he based his handicapping (estimating probabilities) on underused information, the horses he would come up with would help provide him with more attractive odds. So he might estimate a horse’s chances of winning to be 3-1 while the tote board (based on everybody else opinion) would have the same horse going off at 8-1. This is the very heart of handicapping a horse race, betting on the horse who has the best chance of winning relative to his odds.

Applying the concept of ‘Wager Value’ to the stock market you would want to focus on the inefficient areas of the market. Small capitalization stocks tend to be a major source of inefficiency in the stock market. Most mutual funds and institutions want to increase their assets under management so they can grow their businesses and get bigger. Most of them get so big that they price themselves out of the small cap world. The small caps end up being too illiquid for the giant institutions to bother with so they are forced to move up the food chain to the large caps. This means there are less people buying the small caps and fewer analysts following them. This makes them prone to being mispriced. The small cap world is an ideal environment for the small do-it-yourself investor who is far more nimble and quick than his huge institutional counterparts. Of course small caps can introduce additional risks as well. They tend to more unstable then the large caps. They often have just one or two products lines and a smaller customer base. They can be overly dependent on a few key individuals in the executive suite. So you have to be careful. These risks can be mitigated by concentrating on companies that are serving a potentially big market and that actually have growing revenues, cash flow and earnings. You also like to see management own a good portion of their own stock. If it's run by a founder CEO, even better. It’s an attractive area to explore and their financial statements can be easier to read as well, and its great fun and after all that’s all part of the game.

In my own portfolio I hold about half my stocks in large to mid cap names (1 or 2 billion and up), while the other half is in small caps (under 1 billion) so I run sort of a barbell approach in my own investing. It’s a matter of taste. You might want to have just a few of them in your portfolio or hold many and maybe have a larger cash position, it’s up to you.

Great patience is often needed as these firms can be out of favor for periods of time and in this day of the internet can be the subject of bear raids so it’s important to be familiar with the underlying fundamentals of the company. You don't want to be shook out of your position. There are some great small cap mutual funds out there where you can get some unique investing ideas in this area. 

The small do-it-yourself investor gives up a huge advantage to the financial establishment in ignoring this area. Remember when investing you have to have some sort of edge over your competition and the small cap world is a great place to exercise it. And Canada is basically a small cap market and an ideal place to go hunting for under followed small caps.