Oddballs are small companies. From time to time we talk about companies with larger market capitalizations or balance sheets (most always dark, OTC-listed ones) but an Oddball is much more likely to be a $1 million company than a $1 billion one.
Oddballs are opaque. We are always disappointed if we find a company's financial statements readily available because that means the company is much less likely to be inefficiently priced. So the opacity comes from being OTC traded and therefore not SEC-reporting. Oddballs have all different letters of shareholder friendliness and communication, from the detailed presentations of Pardee all the way down to a company like Vulcan International. Besides the paucity of information provided to shareholders by management, the Oddballs do not generate news. Time goes by with not a peep heard from them or about them.
Of course, that paucity of information is why the Oddball Stocks Newsletter serves such a valuable function for subscribers. Even though we make no "recommendations," we help investors in this space figure out what is going on. By the way, the dearth of information that the owners of Oddball companies have about them reminds us of something in the book Panic by Andy Redleaf:
What modern capital markets do very well is raise large amounts of capital from a broad base of investors who are persuaded to give their money to perfect strangers with precious little idea of what these fortunate recipients are going to do with it. In order to keep the money coming in under such admittedly odd circumstances, liquidity and the universal, instantaneous "price discovery" that financial markets offer with a glance at a computer screen are essential. The public investor, knowing so little about what he is buying, must be able to tell himself he can get that money back (or what's left of it) pretty much whenever he likes. [...] Public securities markets, and especially equity and derivative markets, are bad markets because their knowledge base is thin (at least compared to the sum of what could be known about the underlying companies if shareholders were allowed to know it, or inclined to learn it).Compared to bigger public companies, most Oddballs are illiquid. This comes from being small and also from having a small float. Many of the most interesting Oddballs are heavily insider-owned or at least owned by investors with a long time horizon who do not “trade” their stock. So, as small as the market capitalizations are, this makes the effective investible size of the companies even smaller.
Oddballs are older companies. You have probably noticed a number of companies that we have written about that are in the “Century Club,” having been around for a hundred years. And related to this, the Oddball companies are in simple and prosaic businesses. We hear a lot these days about “disruption,” but we think there is something interesting about companies that have been around for a century; especially if they are trading for less than 10x earnings. Also, because the Oddball businesses are older, they tend to be asset intensive. That is, they employ tangible assets that show up on the balance sheet, not intangibles or human capital. And because of this we are often discussing their valuations in terms of book value metrics.
The factors above tend to lead to inefficiency and underpricing of Oddballs because many investors systematically avoid these factors in their investing. Meanwhile, we have noticed that Oddball investors tend to prefer different subsets of investment theses. For example, some like the “cashbox” or negative enterprise value. Some like a very low EV/FCF ratio along with buybacks, so that the company can take itself private quickly if price stays the same. Most Oddball investors seem to prefer overcapitalization and shun debt. Also, Oddball managements seem to want their companies to be overcapitalized, which drives return on equity lower and therefore price-to-book lower.
The pattern of Oddball opportunity over the market cycle goes from just cheap to cheap assuming activism or a "one day" type of liquidity event. Recently there have been quite a few of the one days happening: Paradise, Inc., Vulcan International Corp, Stonecutter Mills Corp, Randall Bearings, and so forth.
Unfortunately, a lot of the remaining Oddballs that have not had their "one day" and continue along earning low returns on equity, cheap relative to the liquidation value of their assets, but which asset value has to be reasonably discounted because they function as jobs programs for insiders. More about that principal-agent problem in Part Two...