Top 5 Insights from Chris Waller on Small Cap Value Investing
My notes from last week's Talking Billions episode
In a recent interview, Chris Waller, founder of Plural Investing and a seasoned small cap value investor, shared his approach to finding hidden gems in the market. Waller, whose disciplined investment philosophy was shaped during the 2008 financial crisis when he was just 16 years old, brings a unique perspective to value investing. Here are the five most valuable insights from our conversation:
1. "Sleuth Investing" Goes Beyond Traditional Research
Waller advocates for what he calls "sleuth investing" – going beyond reading annual reports and financial statements to become an investigative journalist in understanding businesses.
"The idea behind sleuth investing is to go beyond reading some of the easily available materials," explains Waller. "What it's about is becoming a bit of an investigative journalist and trying to really deeply understand a company or an industry."
This approach involves speaking directly with competitors, customers, and others with industry experience. Waller typically interviews 10-20 people before making an investment decision. He also emphasizes the importance of attending industry events and trade shows in person rather than simply analyzing documents behind a screen.
"If you were to own a business, you would probably do more than just look at some of the annual reports of them and competitors," says Waller. "You would probably want to talk to the real people in the industry."
2. Management Integrity is the First Filter
When evaluating potential investments, Waller makes corporate governance his first consideration. He examines four key areas: the shareholder base, board of directors, executive management, and employee culture – looking for alignment with shareholders' interests across all four.
"Generally now for me it's the first filter for any new idea," Waller emphasizes about corporate governance. This approach helps him avoid promotional management teams that might appear attractive at first glance.
He's particularly wary of boards with members who don't own significant shares purchased with their own money or who serve on too many boards simultaneously. Above all, Waller is firm on his principle: "There's really no price that's worth paying to partner with someone of low integrity."
3. Hidden Gems Are Off the Beaten Path
Small cap investing presents unique opportunities precisely because fewer investors are looking at these companies. Waller focuses on businesses with little to no sell-side coverage, where information isn't readily accessible.
"These companies that are hidden, that are less well known are going to be smaller businesses," notes Waller. "There's not lots of information easily available. Some of these companies may operate in an industry where the competitors are private and so there are no other annual reports or earnings calls to assess this industry."
This information asymmetry creates opportunities for investors willing to do extensive research. Waller's example of TerraVest Industries illustrates this perfectly – a company in storage tanks and cast iron boilers that seemed uninteresting at first glance but revealed significant competitive advantages through his research with the founders of acquired companies.
"A lot of people looked at this at face value and said, well, it's in storage tanks and all these kind of industries that don't seem very attractive and really dismissed the company because of that," Waller explains. "And, actually the story that was going on here was much more interesting. You just had to dig a bit deeper."
4. Risk Management Through Downside Focus
Despite running a concentrated portfolio, Waller manages risk by focusing on downside protection rather than upside potential when sizing positions. He defines risk not as short-term volatility but as permanent capital loss over a three-year period.
"I generally size the positions based on the downside, not the upside," says Waller. "I think that's important, particularly when you're running a concentrated portfolio."
His risk management approach emphasizes:
Balance sheet strength (preferring net cash or minimal debt)
Competitive advantages that strengthen during downturns
Management integrity
Attractive valuation
This combination creates a margin of safety: "If you're buying businesses that generally have net cash or little debt, have competitive advantages, run by high integrity people, and you're not paying a huge multiple of free cash flow upfront, generally speaking over time, amount of money you can lose should be relatively limited."
5. Building a Knowledge Database Creates Long-Term Advantage
Perhaps Waller's most underappreciated insight is the value of building a knowledge database over time. Rather than generating ideas solely through screens or write-ups, he systematically builds knowledge about companies and industries that might become attractive investments in the future.
"Over time, you're effectively building a database of knowledge on different companies," Waller explains. "A company that maybe isn't attractively priced today could become so in a year or five or 10 years down the road."
This approach creates a "wish list" of businesses to acquire when market conditions change. The patience to wait for attractive entry points allows investors to take advantage of market corrections, when high-quality businesses suddenly become available at discounted prices.
"When it comes to sleuth investing and attending industry events, sometimes a lot of it is about building up that knowledge database and having the patience to wait and knowing that you've you understand the industry or you've shortcut your learning process now and a future date, this might become interesting."
Waller's disciplined approach to small cap value investing offers valuable lessons for investors at all levels. By combining deep research with a focus on management quality and downside protection, he demonstrates how to find exceptional businesses trading at attractive prices – even in today's challenging market environment.
As Waller defines success: becoming an expert in the small cap space, building a comprehensive knowledge database of companies, and having the freedom to direct his attention where he chooses. For value investors looking to improve their process, these principles provide a roadmap worth following.
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