June of 2015 was a special time.
The vastly underrated Jurassic World was about to become the first film to make US$500m worldwide on its opening weekend and in Harare, President Robert Mugabe had just discarded the national currency in favour of the greenback – 35 quadrillion Zimbabwean dollars for one USD seemed pretty reasonable.
Over on the ASX, the benchmark was heading for it’s first full year loss since 2011.
While in the shadows of the local IT Sector shares in a hitherto obscure small cap Objective Corp (ASX:OCL) — a much under-recognised compounding machine that provides software to government and enterprise customers — hit $2 per share.
According to Andrew Page from Strawman.com, it was a record high which followed “a staggering rally” from just 20 cents a few years earlier.
“This ‘ten-bagger’ was certainly assisted by improving revenue and gross profits, both of which had grown 25% over the previous few years – but a closer look at the journey of OCL from rags to riches provides a more than useful peek into the mechanics of great, stonking growth.”
Re-rate this
For OCL – Pagey says – it was a simple market ‘re-rate’ that did the heavy lifting: the average annual P/E ratio grew from 11 to 30 between 2012 and 2015.
“The market ‘re-rate’ basically pushed the stock price higher. Higher shares mean a higher PE ratio. So in the lingo you say it was ‘re-rated’. It’s a bit of a markets term.
“So for example, if a stock goes from a price of $10-$15 (and pushes the PE from, say, 20 to 30) it has been ‘re-rated’ by the market. The market rates it differently, thinking shares are now worth 30x per share earnings, whereas before it felt they were worth on 20x per share earnings.”
“That’s not to take away anything from those who invested back then — a P/E of 11 was ludicrous for a business that was generating increasing levels of free cash flow while still investing heavily into R&D and aggressively buying back shares.”
Andrew says that value can sit in plain sight for ages – long before the wider market finally cottons on, especially for small caps that more easily fly under the radar.
“With shares today sitting north of $12 each, anyone who invested in the company at $2/share in 2015 has been clearly vindicated. Not only have shareholders scored a compound annual capital gain of roughly 30%pa, but dividends would have repaid a quarter of your purchase price.
“It looks easy in hindsight, though it was anything but. Consider the following, which tends to be true for most long-term compounders.”
Buy the rise
It’s not easy for value-focused investors to buy shares that have already increased 10x in very short order, especially where the market multiple sits significantly above the average, Andrew says,
“After buying at $2, you’d have seen shares drop as much as 30% lower and spend almost two years underwater.
“When shares did eventually start to push higher again, the temptation to take profits would have been incredibly difficult to resist.
“In 2021, you could have cashed out at $10 and pocketed a 5x return — and with the P/E then at 50x it would have seemed more than justified.”
Pagey says that throughout the journey, OCL shares experienced multiple pull-backs of more than 20%, and are presently down 40% from the 2021 high.
“The gains for Objective Corp shareholders may be eye-watering, but they have been hard fought.”
Obscurity to fecundity
“While such examples are the exception to the rule, they are perhaps more common than you might think — ProMedicus (ASX:PME), PolyNovo (ASX:PNV), Nanosonics (ASX:NAN), Audinate (ASX:AD8), Altium (ASX:ALU) are just a few that spring to mind.
“All the above names – virtual king-makers that went from relative small-cap obscurity to industry leaders valued at hundreds of millions (and in some cases billions) of dollars with lots of potential for further growth.”
“While we can always lament having missed out on monster multi-year returns (if indeed you did, there’s more than a few Strawman members who caught plenty of the upside), there should be great solace in knowing that many eventual 10-baggers are likely sitting right under our noses.”
Objectivity
And here’s where the story of Objective Corp and its peers can be instructive, according to Andrew.
“All of these companies had successfully commercialised products and were generating growing sales. Several were already profitable.
“Investors who bought years ago weren’t speculating just on pure blue-sky potential…. No. Share prices a decade ago seem insanely cheap from today’s vantage point, but were actually at or near record highs at the time.”
Pagey says that it was the market itself which was behind the crystal ball.
“The market and its participants were often very slow to react to demonstrated business progress… Painful and protracted drawdowns were common.
“Even accounting for the explosive revenue growth in these companies, share prices often ran ahead of what was reasonable. Of course, the extent and duration that the market overshot things was impossible to predict.”
“All of these companies had (and continue to have) a big focus on R&D and a capacity to reinvest earnings at high rates of return… All would often fall short of analyst forecasts, and most had to suffer through various and not-insignificant business setbacks.”
The bottom line, he says, is that these opportunities are never obvious, they take years to play out.
“And they give rise to many a sleepless night.”
“Which is why, if you hope to catch a baby giant, you need to do your research, build conviction, practice extreme patience, and react with equanimity to (often extreme) price volatility.
Easier said than done, Mr Page warns… “but well worth the effort.”
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