After reflecting on 2025, I have decided to refocus my portfolio and this substack. I will now be focused entirely on illiquid investments, and I will be renaming the substack to “The Illiquid Edge.”
What is the Iliquid Edge?
Liquidity is how much stock trades hands at any given point. You can find it by taking the daily average volume of transactions on a given day, multipled by the stock price. If 10,000 shares are bought and sold on an average day, and the stock trades at $5, then there is $50,000 in available stock you could buy in the company that day. Over 2 days you could buy $100,000 worth of stock. If your portfolio is under $1M you are able to establish a significant position in this company. On the other hand if you have a portfolio of $300M or more, even if you bought all the available stock that day, the position you were able to establish would be essentially insignificant.
I recently spoke with a hedge fund manager, and I gave him a stock pitch. The first question he asked was “is it tradable?” Essentially “is it liquid enough for me to invest in?”
This fund manager manages over $300M in capital. An average position is 10% of the portfolio or $30M. Now say there is a company that trades $50,000 worth of shares per day. In order to build a position without moving the market, you would need to buy less than 20% of the shares a day, and it would take you 3000 trading days or 12 calendar years to enter a 10% position. As you can imagine, no fund would do this—and none do.
I want to be fishing in the areas where these funds are excluded.
To illustrate this idea another way, I’ll borrow a concept from poker. In poker, the single most important thing you can do to increase your win rate, isn’t understanding probabilities or game theory (though those things help), it is table selection. That is, you don’t want to be at a table where everyone is better than you, or as the old poker maxim goes, “If you don’t know who the sucker is at the table, it is probably you.”
Investing is much the same. Always think about what table you are playing at. Are you buying uranium stocks and playing across from hedge funds with the brightest nuclear engineers, ex-regulators, with detailed models of every daily uranium transaction in the world? Will you win at that table? I don’t think so. Such sophisticated investors have large pools of capital, and so can only “play at tables” with a high limit. You have better odds of playing at a table where the stakes and liquidity are so low, that sophisticated players can’t be bothered to participate.
If you do so you can find some incredible bargins.
A few considerations on liquidity and how to avoid “value traps”
From time to time you will find a company that sells for half of what it “should” trade at by any reasonable measure, but never re-rates to the correct price. Investors get upset and call this a “value trap.” Unfortunately, here you are implicitly betting that the market will eventually set a higher price, and it never may. I firmly believe that a successful investment strategy should not be based on other investors bidding up the price. It should be based only on the fundamentals of the underlying company and cash flows. In other words, I wouldn’t bet that the market reprices a security correctly at some point in the future, but I would bet on situations where the market is forced to reprice the security.
That’s why when it comes to successfully investing in illiquid stocks I am looking for situations:
A. When it is clear that the company will be bought. Private equity in many ways are forced buyers, they have to consistently deploy their book of capital, regardless of price paid. Competitors may also buy the company for synergies or “strategic reasons.” In either situation the buyer has a team that know what the company is objectively worth and will pay at least that and often much more. Buyers like these are ideal.
B. The company will be soon included in an index or listed on a major exchange. Indexes are also forced buyers, if a security is included, they will buy it. And the inverse. When an index excludes a security, there will be forced selling regardless of the fundamentals.
C. The company is liquidating, selling assets or ongoing a strategic review that will likely lead to liquidation. If a company is selling for half of what it is worth and will liquidate within a year, that is a 100% return. Similarly, if it is selling for half of what its worth, and sells half of its assets, returning capital to shareholders, the rest of the business is “free”.
D. The company is trading at a discount and buying back stock. This is enormously accretive. For example, say the company’s stock is trading at a 20% earnings yield on equity. If a company buys stock at that price, they are locking in 20% returns.
E. If the company is growing, this provides major tailwinds. If it is selling for half of what it is worth, and never re-rates or experiences one of the catalysts above, but grows at 20% a year, that 20% growth provides tailwinds while you wait for value to be unlocked. Growth also often comes with index inclusions and an increased buyer pool.
My investments always have one or more of these features.
To conclude, my investing rules are:
Invest in companies with less than $100k in daily average transaction volume - “Fish where the fish are.”
Businesses that I understand well enough to reliably predict their future cash flows, discounted back to the present, and arrive at a valuation.
Invest in businesses that once valued I can buy for at least 50% off their intrinsic value.
Businesses that do not have a significant likelihood of permanent capital loss. Generally this means companies with low debt, strong balance sheets and low business model risk (i.e. most mining, drilling companies who have significant commodity risk implicit in the business model).
I only invest in equities that are based in a country with the rule of law, where foreigners are allowed to buy securities outright (so not China), and where they are allowed to withdraw their money at any time (no currency controls).
Management should be at least an excellent management team in an average industry or an average management team in an excellent industry but never an incompetent, abstentee or malicious management team.
In terms of position sizing, I think in terms of opportunity cost. For each investment opportunity. That also means that generally, if my top opportunity has an expected return that far exceeds the rest, I will be concentrated there. If my top opportunities have an equal expected return, I am equally diversified.
Invest in companies that either are growing and present tailwinds to their valuation or that have a strong probability of a future liquidity event (buyout, take private, buybacks, liquidation).
Also my original naming system, choosing an obscure Ben Franklin pen name was probably a bad move. ha!
Looking forward to hearing more! I think you’d like one I’ve been slowly building a position in. Calnano. Trades on the tsx as cno. Very illiquid, under 20m mcap. The only sps milling contracting in the us which is critical for nuclear power and some defense industry parts. They have a great pipeline of work through being the sole distributor of sps machines in universities and commercial facilities. They run a tight ship, decent insider ownership and the CEO worked his way up from intern 20 years ago.