Fluffy Dog Watchlist Stocks For A Rate Driven Sell-Off (Part 1: The Microcaps)

Markets around the world have been selling off as a result of rising bond yields, as I explained in this article. Simply put, the worst affected stocks are businesses that have more of their earnings in the far future and less earnings (or even losses) in the near term.

While it’s hard to argue we’ve seen much more than a few tremors, so far, just as we found last year with the pandemic it can pay to be prepared with a wish list of companies that may start trading at interesting prices.

As the saying goes, “you can’t pat all the fluffy dogs.” This means that we can never expect to take advantage of every good investment opportunity when it arises. However, in order to maximise the chances of taking advantage of opportunities as they come up, it’s worth thinking about stocks you might like to buy ahead of time.

Below, I present the microcap 3 stocks I’m currently most excited about buying in a volatile market. Each of these are small micro-cap companies that I already own. Because these stocks are illiquid stocks, a broader sell of in small caps or growth stocks could see their share prices fall to very attractive levels. Here’s what I’m looking for:

8Common (ASX: 8CO)

8 Common is a software company that has historically been focussed on helping governments and large companies manage their travel (and ad hoc) expenses with their Expense8 product. More recently, the company has expanded into issuing expense management cards, in conjunction with EML Payments. This is basically an extra product that they can sell to existing customers, and they already signed one large customer.

We will publish coverage of 8Common’s recent result soon, but suffice it to say that the company runs reasonably close to breakeven, with a loss of about $350k in the last half, on around $1.9m in revenue. It has about $4m in cash.

Based on its last half, 8Common is currently making around $2.2m in transaction based and software as a service based revenue, per year. On top of that, we know it has already signed a contract that should generate around $500k revenue per year, for its new CardHero product. We can therefore assume that it will be able to get to a run-rate closer to $2.7m in transaction and software in the next year or so.

Going forward, 8Common could build momentum by acquiring other expense card companies or winning new Card Hero clients.

My target buying range in a sell-off: 11 cents per share to 13.5 cents per share.

Corum Group (ASX: COO)

Corum Group is a pharmacy software company that helps mostly independent pharmacies to manage their disbursement of products. Over the last few years, it has lost significant market share with its historical software products because its products did not improve faster enough.

More recently, it has changed board and management, and bought an adjacent company called PharmX, which is what a much broader range of pharmacies use to order products from suppliers and larger distributors. This business looks more like a network effect business than a traditional software business, because it has a majority of pharmacies using it to order products from a large number of distributors and suppliers. It therefore makes the ordering process more efficient for

For retail pharmacies, its website touts the benefits of electronic ordering over manual correspondence with diverse suppliers. For suppliers, it makes it easier to sell to a diverse customer base.

In the last half the company made a net profit before tax of about $600k on revenue of $6.6 million. At the moment, the market is torn about whether to see this as a combination of low growth (or shrinking) businesses or a credible turnaround.

For now, there’s no proof that the business will succeeding in finding sustained, but there is a strong possibility that the (new) management’s strategy of (finally!) upgrading the ageing software for the cloud will reinvigorate growth. The company’s retail pharmacy software is also repositioning to appeal more to larger pharmcy groups, with the ability to let head office set pricing daily/weekly monthly pricing and promotion to all their stores.

There are a fair few moving parts here and lots of risk around the turnaround, but paying below 4 times revenue probably offers a fairly attractive risk versus reward, given it allows for very significant upside if the turnaround strategy does succeed.

My target buying range in a sell-off: 6.5 cents to 8.5 cents per share.

Rightcrowd (ASX: RCW)

Rightcrowd sells workforce and visitor management solutions, which can be as simple as the nametag/ passcard systems employees use to enter office buildings. Covid proved a huge advantage to Rightcrowd, which developed products to help with social distancing (and recording who employees have been in close contact with). On the other hand, it did set back other aspects of the business somewhat.

Covid aside, Rightcrowd’s bread and butter is the need for sometimes complex permission systems that allow different employees into different areas. The company boasts that is trusted by ASX 10 and Fortune 50 companies and that it has over 15 years of experience in automating physical security, safety and compliance processes.

In its recent report, Rightcrowd said “The Annual Recurring Revenue stood at $6.1m at 31 December 2020, and the Company maintains guidance that this will exceed $8m by the end of FY21.” This would imply a fairly good rate of ARR growth. However, Rightcrowd is lost a fairly significant $2.9 million on ordinary revenue of around $7m in the last half.

This is a little troubling, since the company only has $3.8m in cash on hand. Grant income of $4m helped limit cash burn to about $1.2m for the half, but it’s hard to escape the premonition that the company will be raising capital again soon.

Compared to the other two companies mentioned, Rightcrowd is (arguably) higher growth, less well capitalised, and burning cash faster. Therefore I have a wider target buying range (based on forecast recurring revenue).

My target buying range in a sell-off: 22 cents to 32 cents per share.

An Important Concluding Note

As I have previously disclosed, I already own shares in each of these companies. I consider them all attractive at current prices, but my target buying ranges here are designed to give me the confidence to buy more in a market sell-off.

I have found that I am often impacted by broader sentiment. When stocks are going down, I think more about selling, and suddenly it is emotionally so much harder to buy.

Simply by stating what prices I would like to buy these stocks, I hope to increase the chance I will indeed pick some up if the share prices sell down. I’m not guaranteeing I’ll do it, but it is a psychological hack designed to improve my investing.

For example, when I wrote my fluffy dog watchlist for the coronavirus pandemic, I didn’t end up buying all the stocks, but I did end up buying some of them at a time I was rather averse to buying anything; and that has turned out well on balance.

I hope you have enjoyed part one of my fluffy dog watchlist for a rates driven sell off. Part 1 has focussed on three small, illiquid, relatively unknown micro-caps. Part 2 will focus on some (relatively expensive) higher quality growth stocks that might fall back to more attractive levels in the current environment.

Please remember that these are notes from my investment diary only and should not form the basis of an investment decision you make. While this article does cover developments at three listed companies, the article is not financial advice, it is general in nature, and our disclaimer is here.