The Best Microcap Investor You’ve Never Heard Of
CHIP MALONEY APRIL 28, 2016
When I first started researching individual stocks, I initially decided to expand my search to the entire North American equity market. There was an investment firm named First Wilshire Securities that was showing up on a number of microcap companies I examined. I’ve never been shy of stealing stock ideas from smart investors, so I started to look deeper at some of the other holdings in First Wilshire’s portfolio for potential ideas. I found that many of these companies turned out to be really interesting ideas trading at attractive valuations; this spurred me into needing to find out more about First Wilshire Securities and the person behind the firm. This search in turn led me to discover a superinvestor named Fred Astman who helped shape my early investment philosophy as much as any other investment master.
For his amazing track record, very few investors have heard of Astman. He spent his entire investment career under the radar. There has been very little written about Astman, however, he did do a handful of interviews with The Wall Street Transcript and The Bowser Report over the years. A few short profiles of Astman also appeared in BusinessWeek, Equities, and a few other business publications. In this article, I tried to distill what I learned from these sources.
Fred Astman was born on May 29, 1922. He served in the U.S. Air Force during World War II and when he returned from service overseas, he earned a business administration degree from the University of Connecticut. He was later recalled to active duty during the Korean War. Following his active duty, in 1961 he became a stockbroker in Los Angeles, and immediately found a niche investing in small company stocks. In 1969 he was named as manager of a very small mutual fund and found success early on as an investment manager investing in microcap stocks; during one thirty month period in the 1970’s the fund’s net asset value grew by more than three hundred percent. Fred decided to start First Wilshire Securities in 1977, and he would go on to have one of the best long term investment records with average annual returns of nearly 20 percent through the next three decades. According to First Wilshire’s CEO Scott Hood, who shared portfolio management duties with Astman starting in 1998, Astman was “one of the best pure stock pickers that ever lived”. Here are the keys to how he achieved stellar returns.
Astman had a very methodical approach to finding attractive stocks. His search process often started by screening through the thousands of small cap and microcap companies listed in North America, looking for companies that met his criteria. He was a voracious reader and often got ideas from Value Line, the major business news publications like BusinessWeek, Forbes, Fortune, and The Wall Street Journal as well as Standard and Poor’s stock guides. Once he found an interesting idea, he would often look at the competitors, which could often result in his buying other industry players if the whole industry was out of favor. Astman often looked for an interesting change in a company for a reason to buy. For instance, it might have been a change in management, a new acquisition, closing an unprofitable division, a change in product, or a change in direction in an overseas division.
He preferred to own stocks that were neglected by other investors and analysts. Often, the companies that made their way into his portfolio were too small to be of interest to other institutional investors. Astman invested in unpopular industries like direct selling (multi-level marketing) and payday loans. He would invest in companies that were headquartered in far off geographies like Hungary, China, Brazil or Guyana, where most investors were unwilling to tread. Companies on his buy list often had endured a recent industry cycle bottom. For example, Astman loaded up on reinsurance companies after the extreme 2005 hurricane season had temporarily depressed the companies’ earnings. Around the same time, one-quarter of his portfolio was in Asian-American banks spread between six or seven of these banks. Even though these bank stocks were trading at very attractive multiples of book value and earnings, and growing faster than their peers in the traditional banking sector with very little exposure to the overheated residential real-estate market, they were completely ignored by most investors. The common theme among all these stocks was that they were neglected by other investors and mispriced.
He liked to buy stocks with above average growth at below average multiples. Growth was very important to Astman, and he believed that truly small companies held the greatest promise for growth. He liked to buy companies that were growing earnings, cash flows and/or dividends at a minimum of 10-15 percent per year. As important as growth was to Astman, he wanted to buy stocks at a Price/Earnings ratio of less than 10X current year’s earnings – the lower the better. He made numerous purchases of stocks over his career at a single digit earnings multiple, and some as low as 1X earnings. For example, in early 1989, he bought Kentucky Medical Insurance stock at $2.75 per share, when he projected they would earn $2.45 in earnings that year. These early buys resulted in a sevenfold gain within twelve months when his earnings projections came through. That was a common theme among most of his stock picks – buying growing companies at below average earnings multiples.
Astman mitigated risk by insisting on certain qualitative and quantitative factors. He looked for companies with a sustainable competitive advantage who were industry leaders. He wanted to see a solid balance sheet, preferably with more cash than debt, and conservative accounting methods. Companies with short operating histories were discarded and many of the companies he bought had been around for decades, which kept him out of more speculative sectors like technology and biotech.
He was a contrarian in how he bought stocks, and patient in building positions. He liked to buy stocks well before other institutions started buying. Astman preferred to see no more than 5 percent institutional ownership in the stocks that he was buying, and he would often start selling once institutional investors like pension funds and small cap mutual funds got more involved in the stocks he owned.
Astman ran a relatively concentrated portfolio. The majority of his holdings were often in his top twenty to thirty stocks. He set a maximum position size at cost of 5 percent, and he was very disciplined about not chasing stocks that would move out of his buy range. He would mitigate risk by trimming holdings that would grow to above 10 percent of the portfolio, and he was not afraid to hold cash if he couldn’t find anything attractive to buy. Despite being a great stock picker, he was humble enough to admit that one out of four of his picks would be losers, and he diversified accordingly.
Astman was a long-term investor. He had a very low turnover of stocks in his portfolio and averaged about 25% turnover in any one year. Despite thinking long term, he had a strong sell discipline, trimming stocks that became overvalued. However, if earnings and cash flows continued to grow in lockstep with the share price, he continued to hold, sometimes for as long as a decade.
He continued to follow sold stocks and would often recycle old names back into his portfolio. There were a number of stocks that showed up in his portfolio on and off over many years. He called these recycled stocks. He would buy these stocks when they were out of favour and then sell them when optimism returned. He continued to follow the stories, and he would often buy them back again the next time they went out of favor. These recycled stocks often comprised 10-20 percent of his stock purchases. Nature’s Sunshine was one such stock that showed up in his portfolio on and off over nearly 25 years.
Astman preferred a team approach to investment analysis. Over the years, he grew First Wilshire Securities from a one man shop to several analysts and two portfolio managers. He attracted like-minded investment professionals who shared his investment philosophy. He mentored and trained his analysts as generalists, and allowed them to pursue their research wherever it needed to go. Astman guided the investment philosophy of the investment firm, but he felt that taking a team approach resulted in better analysis, and they could cover more companies.
He had a meticulous process for evaluating management. He and his team of analysts would often visit management at their company headquarters, which would often give them clues about how the company was running. He evaluated management based on whether or not they had skin in the game through stock ownership, and whether they were taking an excessive amount of stock options. He was interested in evaluating the CEO but also looked at the history of the other management team members. He also sized up the board to see if they were autonomous. In addition, he evaluated whether management was reporting their numbers on time or not. Astman and his team performed ongoing research to keep up to date on companies.
Astman made an effort to attract long term investors as clients. He wasn’t interested in accepting short term money because he knew that there would be temporary periods of underperformance. However, he was confident that over three to five year periods, his performance would be satisfactory and his clients would do well if they stuck with him. And quite well they did do. If a client had invested $10,000 with Astman when he first put out his shingle in 1977, over a 30 year period it would have compounded to roughly $2.7 million at a 20% annual growth rate.
Astman had a passion for stock picking and shared the rewards of his success. At 82 years old, he was still going into the office for twelve hour days, six days a week, and at 90 years old still showed up five days a week. He was very generous with his time, mentoring not only his analysts, but also met with up and coming money managers who made the trek to visit Astman in Pasadena, California to seek his council. He was also very generous in his philanthropy. He and his wife Jean set up a foundation that focused on helping children locally and globally and did it in a way that was under the radar.
On April 2, 2013, at the age of 90, Fred Astman passed away. Even though he had no children of his own, his legacy is carried on through the charitable foundation he and his wife started, as well as the investment family that he left behind at First Wilshire Securities. For those of us who never had the chance to meet him, but are willing to study his investment process, Astman laid out a framework that investors could use to achieve enormous success investing in small companies. Fred Astman left this world as one of the best stock pickers that ever lived and I, for one, am a better investor for having studied him.
