How I Find Exceptional Small Caps Before the Crowd*For compliance reasons, I have not included detailed past performance figures in this article. The strategy has a strong historic track record, but past performance should not be relied upon as an indication of future returns. Further details, including calculation basis, risks and limitations, may be provided on request to suitable investors.*I look for cheap, high-quality businesses run by good people, in growing industries, where most investors aren’t looking. I concentrate heavily on my best ideas which have the lowest downside and a catalyst to unlock value in the future.1. ValuationMy starting point is always price. I want to pay under 10x EV/EBITDA, and ideally 6x or under. The reason is straightforward: if you pay up for growth and the growth doesn’t come through, the downside can be big. At 6x, the market is pricing in very little growth. You have room to be wrong on the upside case and still come out fine.I do use spreadsheets and often find projecting out future scenarios particularly helpful, as it helps me see the core drivers to the success of the business. Sometimes I do sensitivity analysis on core drivers for the business, to show what could go wrong or right.But the spreadsheet is just refinement and helps build a better understanding for me, if it’s not super obvious it’s undervalued, then the idea is quickly killed.2. QualityCheap on its own isn’t interesting. I see many cheap business that are cheap for a reason (value traps). The business has to be good. I’m looking for high ROIC, gross margins above 30%, and operating margins above 15%. When operating margins are consistently 30%+, that is often a sign of real pricing power, a loyal customer base and /or some structural reason competitors can’t just show up and take share. Quality is very important to me.3. ManagementCharlie Munger famously stated:“Show me the incentive and I’ll show you the outcome.”And “Never, ever, think about something else when you should be thinking about the power of incentives.”So for me, track record matters, but alignment matters more. I want to see meaningful personal skin in the game. Management who are actually aligned to the long-term success of the business. Founders are my favourite, because they built the thing, they think in decades not quarters, and their identity is tied up in the business in a way that a hired CEO’s often isn’t.Any whiff of poor management and for me it’s not worth the mind-space worrying about.4. Balance SheetDebt makes me cautious. When there’s significant leverage on the balance sheet, I can’t justify a large position, and because I like to run a very concentrated portfolio I almost always skip highly levered business. A bit of debt isn’t necessarily bad, it can show management is thinking carefully about capital allocation, but having low or no debt dramatically increases downside protection.Subscribe now5. Industry TailwindsI want the industry to be working with me, not against me. Semiconductors in 2024 is an obvious example. Businesses in structurally growing markets can grow their way out of problems; businesses in declining ones just get cheaper and cheaper until they don’t. Tailwinds also help avoid the value trap problem, if the growth keeps coming, the market will eventually notice.6. Micro and Small CapsThe big funds generally can’t operate in many of my investments. A $50m position in a £100m market cap company isn’t realistic for them, so they don’t look. That creates genuine pricing inefficiency. This is a big part of the edge.And there’s a second-order benefit: when a company I own grows and its market cap passes certain thresholds, institutional money can start entering. This gives you the double whammy of growth in business size and the multiple expansion that comes with a bigger, more liquid stock. I bought QLTU.TA at around an $80m market cap. It eventually traded above $800m. A lot of that move was just the market catching up, and pricing in the growth that was already present.7. Small NichesI actively prefer businesses with a small total addressable market. A small TAM deters competitors. If the prize at the end isn’t big enough to justify the cost and risk of entering, most rational businesses won’t bother. The time and cost it would take a new entrant to build the required expertise and establish a credible reputation, just doesn’t make sense when they could just acquire an existing player instead. That dynamic keeps competition low and margins high.8. Track Record and ConsistencyI want to see several years of history, enough to understand what normalised earnings and margins actually look like. But what I’m really paying attention to is consistency. Revenues growing steadily year after year, not swinging around with the economic cycle. That kind of consistency tells me there’s a recurring revenue model underneath, real customer retention, and a product that is sticky. That’s very different from a business that had one good year.9. Finding What’s UndiscoveredMost of my ideas come from a bespoke screen based on Greenblatt’s Magic Formula. I absolutely love treasure hunting. I can spend 6 hours solid and forget anything else in the world come out with 3 interesting companies to look into in more detail. This is how I find businesses that haven’t been written up, aren’t discussed much online, and are sitting quietly being excellent without anyone noticing. When a good business is genuinely unknown, the discount to fair value can be substantial and completely unrelated to the fundamentals.When I go through the list I try to ‘kill the idea’ as quickly as possible. Then I can get to the next one. Valuation too high, pass. Don’t understand the future of the business, pass. Poor management, pass. You get the idea. It works very well.10. Position SizingWhen I’ve found something where the downside is genuinely low, I want a large position. Swing hard and make it count. My maximum at cost position size is 30%. The QLTU.TA setup was a good example: 30% of market cap in cash, consistent growth, strong margins, sector tailwinds, and trading at 6x EV/EBIT. Growth simply wasn’t priced in at all. Even if growth had stalled, the downside was minimal. That earns a full allocation. I’m not interested in having 25 positions with 4% each, if I’m right, I want it to matter. I find so few of these, maybe one a year, but they sure do contribute to overall return.30% at cost is a massive position by anyone’s standards, but what I do that I don’t hear anyone else talk about (probably because there are so few positions that justify a 30% allocation)… Is that I trim a lot if the stock goes up. If I think the business is worth say 3x current valuation, and it goes up say 75%, and I still think the thesis is playing out well and business performing, I will often cut the position in half and take substantial profits. This allows me to benefit most when the risk reward is at its absolute best, but gradually as the thesis plays out the risk reward worsens and for peace of mind and risk management purposes, I will reign it back in.I’m not looking for quick wins or crazy gains, and for me never sell, is just poor risk management. There are many very successful games to play in the market, but I’m clear that I’m not playing the get rich quick game or the never sell game. I just want to manage the risk reward as optimally as I can and only play games where I believe the downside is low.11. Portfolio ConstructionI run a concentrated book, usually no more than 10 stocks, with the top three making up around 60% of the portfolio. The logic is pretty simple: my 12th best idea is a lot worse than my top three. Buying it anyway just to deploy capital is how you dilute returns. I’d rather keep it on the watchlist and potentially buy if risk reward dramatically improves.12. Using Technical AnalysisFundamentals drive everything, but I do use technical analysis to time entries and sometimes exits. If the valuation is great and the stock is in an uptrend, I’ll take a full position. If it’s interesting but in a downtrend, I wait. I watched Santec (6777.T) for a while after first spotting it at around ¥5,500. It dropped all the way to just under ¥4,000. I waited until it had bottomed and started recovering, and began building my position around ¥4,400. Waiting for that turn rather than catching a falling knife made a real difference to the entry.I know many fundamental investors who turn their nose up at the mention of Technical Analysis. And I certainly can’t claim to be any sort of expert or strong believer in the majority of what the TA crowd swear by, but I’m not averse to using a tool just because it is out of favour with some people I respect.I view TA similar to a shadow, there are some flows of capital that are driven by non-fundamental items, such as a forced seller, tax loss harvesting, or, very commonly in microcaps that there are a meaningful amount of retail traders playing the TA game and make it into a self-fulfilling prophecy. TA players can often be the marginal buyer or seller in a fairly illiquid small cap.Who’s to say what is right or wrong, I just don’t want to fight with reality, and the reality is in my opinion TA is worth thinking about for entries and potentially for exits.13. Special SituationsIn volatile markets, I look to increase my allocation to special situations: things like buyouts, spin-offs, situations with a natural floor etc., where the outcome is driven by a specific corporate event rather than the general market. It’s a useful way to reduce sensitivity to macro noise when everything else feels uncertain.For special situations because it all depends on the dynamics of the setup, so all the rules I have about quality of business aren’t so relevant, although I wouldn’t invest in a business that I was worried about management.Special Situations Global Equities is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.What I AvoidI stay open-minded and will revisit ideas I’ve previously dismissed. But experience has given me some useful heuristics / shortcuts to killing ideas quickly:1. Airlines, auto manufacturers, and other capital-intensive businesses that have a commodity like product that faces strong competition.2. Fashion and anything trend-driven, because the business can look great right up until it doesn’t.3. Heavily leveraged businesses, because I can’t size up comfortably in a concentrated book.4. Turnarounds, they’re much harder than they look, and I’ve seen enough of them to be skeptical.5. Any management team with a track record of poor capital allocation or, worse, any hint of fraud.6. Banks and insurers, mainly because I find it genuinely hard to get conviction on their earnings quality. (And I was an actuarial consultant so know how these guys manipulate assumptions)7. Early-stage businesses with limited history.8. Anything in a structurally declining industry.9. High-upside speculative plays — even when the probability-weighted return looks attractive on paper, the binary risk means you’d need a huge number of them for the math to work. With a concentrated portfolio, I can’t play it that way.The whole thing comes down to finding businesses that are genuinely good, run by people I trust, with a catalyst, and at prices where I’m not paying for things that haven’t happened yet; and then having the conviction to own enough of them that it actually matters.I view my role as a capital allocator in the world, and want to allocate to great business that are solving real problems for real people.I care about the business, the people running it and the positive impact on the end consumer.I also care about my investment partners, who invest alongside me. I like to meet each one and make sure they are similarly aligned.I’m not doing this ‘for work’, I’m doing this because I love it and am passionate about it and find it infinitely fascinating, and I want to share that enthusiasm and the fruits of that labour with others.Ultimately I do this because I find it a deeply meaningful pursuit and it helps me become a better version of myself, and learn a huge amount on a vast number of subjects. It’s a real exploration of life, how the world works externally and also how the human mind works with all its complex behavioural psychologies built up from all the past experiences and innate human presets.If you want to learn more about the Special Situations Global Equities (SSGE) Fund, which is run according to the approach above, feel free to get in touch. Open to investors internationally.I’m happy to share further details via email. Please do reach out to find out more.If you have got this far, I truly appreciate your support and interest in what I have to offer and hope you have found some value here. If you have, I would greatly appreciate any form of sharing or recommendation or even a positive comment, as this greatly helps me on my journey.Very best wishes,JoeShare Special Situations Global EquitiesSubscribe nowLeave a commentDisclaimer:Nothing here is investment advice. It is purely a way of me gathering my thoughts and sharing them.This letter was originally written for my investment partners, but I’ve opened it up to the public who may be interested in my investment strategy.Past performance is no guarantee of future success.42% CAGR over 6 years relates to my personal portfolio, which is unaudited, although you can piece together my track record from the past post on the Substack. The SSGE investment strategy has a separate past performance, and very closely reflects my own personal portfolio but often with slightly less risk. Performance for SSGE for 2024 was around 60% and for 2025 around 50%. I can provide more details on request for those interested.Everything written here is purely my own personal opinion and not a reflection of the businesses I’m associated with.Special Situations Global Equities is a reader-supported publication. To receive new posts and support my work, consider becoming a free or paid subscriber.