Reflexions on fiscal 2023. Where to now?-Focus on micros.

In many ways 2023 was my kind of market. With much fear around, speculative themes getting smashed (outside of Li) but the market grinding higher, carried by quality growth. IMO it's not surprising that my portfolio had a good year. Carried by the big weighting to large cap stocks. Being around 80-90% of the total, (the rest mainly intl), as a group doing quite well. One measure of this is that I had 16 stocks delivering 25% or better for the year and only one stock delivering less than minus 25% for the year.

I realise the best way to look at this is to do a standard deviation round the market return. then looking how many stocks you had in each tail. That is more precise, but I can't be bothered doing that-maybe when I was 20 or 30yo. (lol).

The problem now is that many of the large cap stocks, on my valuations, are fairly valued or fully valued. Much of the remaining standout value from a long-term valuation perspective is in retail. And we all know the issues facing that sector. Being, that they have been largely overearning over the last couple of years with the prospect of a severe downturn in consumer spending about to commence. A recession is possible bringing potential under earning by the sector in the future? So tricky but this is the area of real interest to me. One to approach with caution. At some stage I could see myself buying some more into this sector. At the moment I hold Breville and Lovisa-would add to both on weakness.

However it is micro’s, that offer interesting prospects at this stage of the cycle in my opinion. As most people would know they have been smashed this year. A lot of that is giving back the over valuations that came from unsustainably low cost of capital, driven by effectively free money. Most people actually understand that now. Even if they didn't understand that a year or so ago (lol).

In my opinion, historically, micro's are a difficult way to make money. If you would ask me anytime during the 1980s, 1990s or any time before the GFC really, my view of micros, I would have said that the severity of liquidity and economic cycles really play against them. Small businesses need access to funds and a long benign economic environment, to give time for management to put their plans in place and build the business that is sustainable and has a strong fiscal standing. Extreme volatility in the funding environment through liquidity movements, or economic booms and busts, are very dangerous for these types of companies. with that perspective, the period 2012-2021 could be seen as a golden era for micro type companies and businesses. They are given access to funding and also time to develop into real businesses.

Where to from here? It is possible we go back to free money, low cost of capital, benign economic conditions and all micro’s thrive again. That's possible. But not probable. I think we're in for a time of testing conditions where the micros who make it really have to be much more evolved, lower risk business plans and much more firm financial footing than they have been in the past is my opinion. Of course, markets being markets, there are always just enough outliers to cast doubt on any theory.

especially for micro stocks. Their share prices are a weapon. This is because they need confidence in their business, from customers, suppliers, financiers, and potential access to funding, even if not required. A strong share price gives them this ability and confidence. In lots of ways, a poor share price can be poison. The level of their share price are much more important for these companies as opposed to large companies. For companies like BHP or Telstra, the actual share price (outside of extremes), doesn't really matter to the underlying business or management (outside of STI’s). It will grind on. Micros with very poor share prices, I don’t see as opportunity but a possible death knell or large handicap.

In my view, micro share prices, are now at valuations we haven't seen for many years. As you can see, I'm usually not a bull in this area. My views have also changed since being on Straw Man. Historically I would believe that micros are a pure punting area. With real money being made in the big caps. I have to partly thank @Winnie for this realisation. Who analyses micros, as I would analyse large caps, which means running business metrics. The future for the sector, especially in a risk adjusted way, is likely to be following real businesses, real profits, a real cash flows, measuring management against realistic goals.

During this calendar year I have tripled my exposure to micros. It would be very disappointing if we saw a recovery in micros over the next two years but that didn't include the stocks I held. Very disappointing. who will be the winners going forward? In my view it will be those companies with real businesses. Proven unit economics. + Cash flows. top line growth. Management execution success. success is likely to be granted to a much smaller universe than it has been over the last decade, in my view. More in line with the pre GFC era.

In summary. I still love my large caps. It's my knowledge base and my wheelhouse. However, I am spending much more time on micros. And hopefully picking out those businesses that can come out of this unscathed and look much better two years out. I think it is possibly where excess returns will come from.

Thanks for reading, that's my view. Of course I could be wrong.