Investors Focus on Microcaps as 2020 Comes to a Close

The movement for a dedicated style box for microcaps seems to be gathering momentum. Though traditionally considered a subset of small cap, the success rate of investments in the $50-$300 million market cap range has many investors rethinking their allocation strategy.

You don’t have to sell Ken Korngiebel on microcaps. The lead portfolio manager at the Wasatch Microcap fund (WMICX) regularly beats the Russell Microcap Index by a wide margin. Their average annual return for the past five years has been right around 25%.

That’s a big number, but not nearly as impressive as the 18% Wasatch has averaged over the past decade. Even taking into account the most recent bull market, that’s a good run, and it’s not over yet. Kornigiebel believes the outlook for microcaps in 2021 is just as good.

“I can’t predict where the economy will go,” Ken said in a recent interview with Barron’s. “The markets are in an in-between phase and there are some opportunities to recycle companies that have been historically big winners. Some of those are squarely microcap.”

Analyzing the Wasatch Microcap Fund Investment Strategy

Wasatch invests in companies with a market cap of less than $1.5 billion, which matches the largest companies in the Russell Microcap Index. They don’t automatically sell holdings when they exceed that mark, but they won’t add a new holding that doesn’t fit this criterion.

Korngiebel, who charges a 1.66% management fee, has the portfolio investments separated into two buckets. The first is for disruptive companies expected to double in size within three years. The second is more long term, with a doubling outlook of at least five years.

The top earner in the first bucket has been Kornit Digital (KRNT). First purchased by Korngiebel in 2017, the company’s market value has increased from $500 million to $3.6 billion. In the second bucket, Transcat (TRNS) has gone from $150 million to $240 million since 2018.

Microcap Success Stories during the Pandemic

Purple Innovation (PRPL), makers of the Purple Mattress, was added to the Wasatch portfolio in March of 2020. They were listed at $650 million, down from a $1.1 billion valuation they had secured after a merger in 2017. Today, they’re up to $1.6 billion.

This is a pandemic success story, one worth paying attention to. Purple has a substantial retail presence, but the real value is in their online and mass media marketing. With consumers stuck at home during Covid-19 lockdowns, Purple’s sales numbers jumped dramatically.

They’re not alone. Celsius Holdings (CELH), a microcap company that markets energy drinks online, is up 562% year-to-date. Five9 (FIVN), which controls 15% of the $24 billion contact center software market, is up 122% YTD and 92% annualized over the past five years.

Microcap Investing Suggestions for 2021

Ken Korngiebel is already looking to the future, which is what he gets paid for. The Wasatch Fund will see some new investments in growth companies from some of the industries hardest hit by the 2020 pandemic. That will likely include airlines, hotels, and travel stocks.

Though not specifically mentioned by Krongiebel, Mesa Air Group (MESA) has started popping up on a number of watch lists. They run regional flights for American and United Airlines. Mesa, like all airlines this year, has seen its stock prices plummet, making it a good time to buy.

A full economic restart, which we really haven’t seen yet, should boost share prices for smaller airlines like Mesa. Another possible beneficiary will be Travelcenters of America (TA). It was once considered a bad bet with a weak upside, but they showed a gain of 209% in 2020.

Diversifying Your Portfolio with Microcap Investments

You can follow some of the tips in this article and invest in microcap companies that either show promise or have exhibited strong performance numbers in 2020. You can also just buy into the iShares Microcap ETF (IWC). It’s up 20.30% this year.

Performance reports don’t show microcaps as a separate style box, so you’ll need to create buckets to keep track of investments in this space. Set your own parameters when you do this. The market cap range for microcaps is often disputed by financial analysts.

Keep in mind that microcap companies often grow out of the microcap category into small or even midcap. For tracking purposes, don’t take them out of the bucket when this happens. It will skew your aggregate performance numbers for this portion of your investment portfolio.

How much should you invest in microcaps? That’s entirely up to you. Smaller companies come with a higher risk factor, but the potential rewards reflect that. Do your homework, use common sense when picking your stocks, and invest only what you can afford.

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About the Author

Investors Focus on Microcaps as 2020 Comes to a Close

Kevin Flynn

A former financial professional and founder of AdvisorScale Financial Writing, Kevin lives in Leominster, Massachusetts with his wife Evelyn, two cats, and nine wonderful grandchildren.