Idea Brunch with Luke Wolgram on Microcap Investing
Welcome to Sunday’s Idea Brunch, your interview series with underfollowed investors and emerging managers. We are very excited to interview Luke Wolgram!
Luke is a professional microcap investor and ranked #1 globally for accuracy on TipRanks in 2021. He is also the author of the Uncommon Profits newsletter and was an early investor in high-performing companies like Leatt and Xpel. Luke is also active @LukeWolgram on Twitter.
Luke, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and your love for microcaps?
I bought my first stock back in 2013 when I was 17 years old. My dad was a stockbroker and had begun to teach me about stocks. I was initially more interested in shorter-term active trading (based mostly on technical analysis) but soon pivoted to options, and then to fundamental analysis. Most of what I do now is fundamentals based, although I’ll still occasionally take a technical or options trade. I switched from a computer science degree to a finance degree after my first semester of college. I graduated with a finance degree at the end of 2018.
I have been involved in microcaps since I pivoted to focusing on fundamental analysis. It was clear to me that microcaps offered a structural advantage to individual investors and smaller firms because larger institutions are unable to invest in them. In addition, management teams are far more accessible in microcaps. I can shoot an email to a microcap CEO and often get an answer within a day. This is something that would never happen with large caps (although occasionally you’ll find a microcap where management wants nothing to do with investors).
Most of what I know today has been self-taught through books, online resources, and my own experience.
Your most successful investment has been Xpel Inc (NASDAQ: XPEL), which is up ~20x since you first bought it. Can you walk us through how you first found the company, what was appealing at the time, and where you think the company goes from here?
I originally found Xpel through a YouTube video from a Tesla investor. They had noticed a lot of Teslas were getting Xpel’s paint protection film installed and had made a video on Xpel when it was a little over $1 per share. By the time I watched the video, Xpel was already in the $4.00s. Nonetheless, I thought the company was intriguing and it still looked incredibly cheap considering its growth rate, around 10-11 times annualized earnings. They had just reported Q1 2018 numbers where revenue grew 99% year over year and net income had jumped from $0.01M in Q1 2017 to $2.8M in Q1 2018 demonstrating clear and substantial operating leverage. This was around May 2018. I began to research the company more and it quickly became apparent that this was a high-quality business with a long runway ahead of it. At the time, I put all of my money – around $3000, I was still in college – into the stock and a decent chunk of my parents money (which was considerably more).
Since then, Xpel has come a long way. Annualized revenue run rate was around $100 million when I first bought it with run rate profits at around $11 million. Today, Xpel has run rate revenue of $336 million and run rate profits of $48 million. The multiple of run rate earnings has increased from 11X to 38X.
I believe they will be able to continue to grow revenue and profits going forward at a solid double-digit percentage rate. Assuming we don’t get a severe recession in 2023, I have Xpel’s 2023 earnings between $2.50 and $3.00 per share, well above consensus estimates. This puts the multiple today in the mid-20s on my 2023 earnings numbers. It’s certainly not as cheap as when I first bought it, but I don’t think that’s particularly expensive on a forward-looking basis for a company of Xpel’s quality and growth rate either. It’ll probably take a long time to get a 20-bagger out of Xpel again now, but I do think investors may very well see above-market returns from the current stock price over the next 5 or so years.
What are your favorite ways to come up with new investment ideas and what are the necessary ingredients for a great microcap investment?
Currently, I find new ideas mostly through Twitter, MicroCapClub, Substack Authors, Seeking Alpha, and Value Investors Club. A well-curated Twitter feed and being a part of a website like MicroCapClub where new ideas are posted every month can be a huge time saver for finding new ideas. I’m essentially outsourcing high-quality idea generation for free from other good investors.
That said, I’m currently working on my own process to find some more unique ideas. This includes going through lists of stocks on an exchange from A-Z or developing fairly wide screens and going through the results one by one. Sometimes these screens will be as simple as looking at every company in a market cap range, say $50 to $300 million, in an industry/sector in one country. Sometimes I’ll add further metrics such as profitability and revenue growth rate.
Many microcaps are known for poor governance, insider dealing, uneven treatment of shareholders, and ineffective leadership. Are there any microcap CEOs that stand out to you as exceptionally strong or high integrity?
Xpel is no longer a microcap but is what I consider to be the gold standard for microcap/small-cap management teams. Xpel has an excellent CEO, Ryan Pape, who at one point very early as CEO put $25,000 on his personal credit card to pay off a company payable. Pape bought around 1.4 million shares with his own money for pennies per share early in his tenure as CEO (Xpel was quite literally a penny stock at that point). He has sold fewer than 10% of these shares since. Other directors and executives at the company have also owned shares, resulting in significant insider ownership and management incentive alignment with shareholders. Ryan Pape understands capital allocation and Xpel has consistently made good acquisitions at reasonable and attractive valuations. I have found Xpel’s management to have high integrity. They don’t put crazy targets out there, but they execute and often beat expectations. They also don’t hide things if they have a weak quarter. Xpel has retained skilled staff throughout the pandemic as it’s the right long-term decision to do so when they probably could have let people go to boost short-term profits. Xpel tries to help create value across the entire paint protection film chain for everyone involved. I haven’t quite come across a microcap with as good of a proven management team as Xpel, but there certainly still are some good ones out there. I think you need to look at management’s track record to really get a sense of how they behave. Many CEOs will talk the talk but not walk the walk.
What are two or three interesting small-cap ideas on your radar now?
Here are three ideas I think are compelling today:
Leatt (OTC: LEAT — $115 million) is a South African-based global distributor and brand of motocross and mountain biking equipment, gear, and apparel. The company was started by Christopher Leatt nearly 20 years ago. He had seen a friend suffer a fatal motorbiking accident and decided to develop a neck brace that could prevent such injuries. Leatt developed and patented the neck brace and has had a near monopoly on the product ever since. Many neck braces you’ll see today are either Leatt branded, or white-labeled with another brand but still produced by Leatt. Starting in 2016, Leatt began to expand product lines moving from a neck brace company to developing a full range of protective equipment from head to toe, including helmets, body armor, knee and shin guards, shoes & boots, goggles, and apparel. The strategy has proved successful so far with revenue growing from $16 million in 2016 to $72 million in 2021. Incredibly, over that time operating expenses have only grown from $9 million to $16 million, resulting in profits exploding from a net loss of $0.5 million in 2016 to over $12 million in profits in 2021.
Leatt trades at just 7 times TTM EPS. Bears would say that Leatt is a pandemic winner and would criticize the company’s lack of cash flow relative to earnings. These are certainly risks, but I think the counterarguments are quite simple. Leatt has been growing quickly since well before the pandemic. They report Q3 ‘22 results soon. If revenue and profits show growth again YoY or are even flat, then I simply don’t see how you can continue to argue they’re a temporary pandemic winner when we’re seeing other pandemic winners report devastating earnings. As for cash flow, Leatt has invested a lot into working capital, specifically inventory. Growth takes cash. The company opened a new US warehouse this year that triples its US distribution. That takes a lot of cash. I expect once growth slows, we should see more cash flow come in.