Buying High and Buying Small

By Joel Litman, chief investment strategist, Altimetry

You’ve probably never heard of Richard Driehaus… but he’s one of the most successful investors of the past 40 years.

Driehaus started his self-named hedge fund, Driehaus Capital Management, in 1980. He generated 30% annualized returns over a 12-year period.

That means if you had put $10,000 in his fund, it would have turned into $246,500… five times what you’d have made by investing in the benchmark small-cap Russell 2000 Index.

Over the past 20 years, the Driehaus Micro Cap Growth Fund has carried on Driehaus’ strategy. It has been up 17% per year versus 7% for its benchmark, the Russell Microcap Growth Index.

Driehaus may not be as famous as investing legends like Warren Buffett or George Soros. But he has had just as much of an impact on his corner of the stock market. Institutional investors regard him as one of the first true growth and momentum investors.

His philosophy is to buy companies that have strong earnings growth and rising share prices… with the expectation that as earnings keep climbing, so will the stocks.

In other words, Driehaus’ strategy is to buy high – and sell higher.

But while people focus on his legacy of growth investing, they miss the other reason for his incredible success. It’s also the reason why most investors don’t know about him…

You see, Driehaus focused on microcap stocks…

That’s an area most institutional and individual investors overlook and ignore. He went hunting for high-growth companies in the highest-growth area of the market.

There’s no official cutoff for what’s considered a microcap. For the purposes of our research, we consider them to be companies with market caps below $2 billion.

Driehaus cemented his legacy because he understood that microcap companies can offer the biggest upside. Think about it…

A microcap company can double its revenue much more easily than a tech giant like Apple (AAPL). And a microcap company doesn’t need to dominate big markets to generate massive earnings growth. It just needs to take a sliver of its niche market.

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Companies like frozen-yogurt chain TCBY, TV company Home Shopping Network, and Chinese e-commerce firm Vipshop didn’t grow to dominate the world… But they produced phenomenal returns for Driehaus.

That’s because they started as tiny businesses and grew into niche dominators.

When Driehaus bought TCBY stock in 1984, the company’s share price was in the single digits. Its market cap was below $150 million.

The stock eventually hit $200 per share, becoming a 30-bagger along the way.

TCBY’s stock didn’t rise because the company became a ubiquitous frozen-yogurt business. Driehaus generated his 3,000%-plus returns because the company became a reasonably sized niche player in the frozen-dessert market.

Driehaus took a position in Vipshop in December 2012. The company had a market cap of $900 million. It didn’t need to become the No. 1 Chinese online retailer. It narrowed its focus to discount luxury items, which was a specific niche market.

As Vipshop’s fundamentals accelerated, its market cap rose to $8.4 billion by March 2014… and Driehaus started taking profits after making more than 8 times his initial investment.

Those types of moves are incredibly rare for large companies…

That’s because of something called the “law of large numbers.”

It’s hard for large businesses to grow quickly. If you only have 1% market share, it’s not that hard to double your share. If you already own 50% of the market, that’s a much taller task.

Much smaller companies – microcap businesses that are undiscovered and primed for growth – can generate incredible returns.

A lot of people are scared of investing in microcaps. But they’re missing out on some of the best potential gains in the market… the ones most folks never even try to access.

Wishing you love, joy, and peace,

Joel
May 31, 2024

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