Small-Cap Deep Value Portfolio - 2/3/2026

Let’s talk about the deep value portfolio inside The Flagship Report. (To skip right to the portfolio, click here.)

I cut my teeth as a small-cap deep value investor. When I left basic financial services at John Hancock, working with insurance, mutual funds, partnerships, and the then-infant industry of financial planning to become a broker, I thought I knew more than I did and quickly got myself into trouble.

A colleague in our office was exceptionally skilled at investing. He worked as a broker because back in the 1980s as this was the easiest and most inexpensive way for him to manage his family and friends' portfolios. He was putting up impressive numbers, and I begged, asked, hounded, and nagged him until he gave me a couple of books to read and told me to go away, thinking that would be the end of it.

I read both books over the course of a weekend. One was The Intelligent Investor and one was Marty Whitman's Aggressive Conservative Investor. I was not popular around my house that particular weekend, but they changed my life.

Both focused on deep value: buying undervalued assets with a strong credit profile. Graham talked at length about the concept of margin of safety, Whitman expanded on the importance of credit and that is exactly what we are doing in the small-cap deep value portfolio.

We are searching out small stocks that are undervalued and way off Wall Street's radar screen. These are not the most popular stocks. We stay pretty small, most of the time remaining under $2 billion in market cap. We will occasionally creep above that to $5 billion, but only for extraordinary opportunities.

Most of the time, markets are fairly efficient. So many eyeballs, people, funds, and analysts look at large stocks that it creates efficiency. The arrival of artificial intelligence and the speed and accuracy with which it can analyze stocks is going to make markets even more efficient.

However, there is that little corner of the market I call small-cap deep value where nobody is really looking. These are unloved stocks. They are small. They are not exciting. They are usually not technology. They are not the ones on the news. They are not getting written up in Barron's. Reddit does not care about them at all.

Small-cap deep value rests on a couple of old fashioned beliefs: prices are not always the same as value, human beings routinely overreact and underreact, and they misprice what they do not understand or, more importantly, do not care about.

Above all, as Charlie Munger discussed at length in the years before he passed away, the best opportunities today tend to live in the parts of the market where the fewest people are being paid to look.

That is why small-cap value does not just work and is not just profitable. It is ridiculously profitable when you look at the long-term results I have delivered, the historical backtests, and the data.

This works as well as momentum and at times better. There is a whole school of thought that putting these two strategies together creates a powerhouse portfolio, and we will talk more about that later.

We are not contrarian for the sake of being contrarian. We are looking for assets that trade for less than they are worth. We are very asset centric. We do value cash flow, but if you ask me to choose between a stock cheap based on cash flow or a stock cheap based on asset value, all things being equal regarding credit conditions, I am going with the asset value 100% of the time.

Margin of safety is the key to this strategy, and it is why it works. Margin of safety is not just a slogan.

It comes from engineering. If you are going to build a bridge and you expect 10,000 pound cars and trucks to drive across it every day, you build the bridge to safely carry 30,000 pounds routinely every day.

You build in a margin of safety.

In investing terms, you are not trying to buy the fastest growing company. You are not trying to buy the company that analysts all like. You are trying to buy cash generating assets where, because of disappointment, bad headlines, and some operational stumbles, there is a gap between the price and the value.

That is our first level of safety. We have all these assets, and we have paid a lot less than the assets are worth. Theoretically, at some point, something good is going to happen. Whitman called it resource conversion to profit: convert those assets to their true value.

We go further than just buying a dollar for 40 or 50 cents. We insist on financial strength. We check the fundamentals and the credit rating of the company to make sure they not only have sufficient asset value to pay us back if the company gets liquidated, but they have the credit required to survive as a going concern, a viable business.

Eventually, the resource conversion or a re-rating of the stock because it comes back into favor will deliver the returns we are looking for.

We have two levels of margin of safety built into the portfolio. If we acquire income producing solid assets, pay less than they are worth, and make sure they are going to be able to stay in business and management is not looting the coffers for their own benefit, eventually the stock is going to go higher.

If we take care of the downside, the upside over time will absolutely take care of itself.

Many people will tell you deep value does not work, that it is not popular, that value funds do not perform well, that value ETFs underperform. That is all true for large scale attempts at value investing.

But value does work when you apply it properly. What it does not do is scale. If you take this twin margin of safety, creditworthiness, and financial strength philosophy and apply it to larger companies, you are not going to find very many opportunities.

The universe is too small for the big players to even consider being involved. If Fidelity wants to make a meaningful investment for their fund investors in a $50 million company, they have to buy the whole company.

You and I, thankfully, do not have that problem.

This is how Warren Buffett got started. The first several million dollars came because Buffett was a small-cap, deep value investor.

Then there is Walter Schloss, who worked with Buffett and took classes with Buffett. They both worked at Graham-Newman and studied under Ben Graham. When Schloss went on his own after Graham-Newman dissolved, Buffett went one direction and Schloss went another. Schloss was a New Yorker who stayed in New York while Buffett went back to Omaha.

Schloss spent 47 years buying stocks under book value that had a twin margin of safety. Walter Schloss compounded money at 20% a year for decades. He did it away from Wall Street. He did not listen to analysts. He did not have a computer. He had a phone and a copy of Value Line and an S&P Stock Guide.

That is how he ran his business.

We can do it a little quicker and more efficiently today, but it is exactly the same thing.

What makes this really attractive is the high returns. You are talking about the potential for double and better the overall market's rate of return over time. It is very volatile.

Keep in mind that for small-cap deep value investors volatility is merely a source of opportunity.

If you are looking for high returns without volatility, that does not exist. But in small-cap deep value, this is one of the few areas left in the market where your competition is not someone with a supercomputer trying to shave microseconds or fractions off each and every order. Your competition is institutional constraints. You are in a yard where the other kids, the big kids, cannot get into the yard. It is like a dog park. You have the big dogs over here and the little dogs over here. This is one where the big dogs have to stay over there. You and I, as individuals, can come in here. We can buy a $25 million bank at 80% of tangible book value. We can buy a company worth $100 million, but whose property, plant, and equipment are worth over $200 million because nobody cares about the online marketing business.

If you have ever seen Other People's Money with Danny DeVito, this is exactly the same thing. New England Wire and Cable traded for less than half the value of the business. It was a $25 value with a $10 stock price, and DeVito's character bought it with the idea of liquidating it. I am not going to reveal the whole plot, but if you have not seen the movie, watch it. It is a fantastic film that explains small-cap deep value perfectly.

We are looking for businesses that nobody really cares about, that are out of favor, that are too small for the big players to get involved with. We can buy the assets for a lot less than they are worth to a rational buyer, and own it until the stock is taken over, liquidated at a profit, or re-rated higher as some Wall Street analyst stumbles across it.

We do close many of our positions because of takeovers.

We use a global approach because going global with our small-cap deep value portfolio opens up all kinds of opportunities.

As the Magnificent 7 lifted all boats higher in the United States, it became tough to find small-cap deep value or any kind of value ideas. Then we looked to Europe and Asia and found scores of Japanese companies trading below book value with ridiculous margins of safety and tons of cash.

We found companies all over Europe (banks, manufacturing companies, defense companies) trading at ridiculously low multiples of the value of the assets they own with great credit profiles. This increases our opportunity set because just because everything is lovely at home does not mean Europe is having a great time or that there is not some smaller nation in Asia that is struggling a bit where you can buy assets at bargain basement prices.

We go global for the simple reason that that is where the money is.

When you go back and look at history and some of the most successful investors of all time (Warren Buffett, Charlie Munger, the folks at Tweedy Browne), they all started and have their ties all the way back to that classroom at Columbia University where the teacher was Ben Graham.

During the late 1960s and 1970s, one of the worst periods ever in the markets, Tweedy Browne compounded money at about 20% during that period. Tweedy Browne had been Graham's broker and eventually edged into money management because that was more profitable than just being the broker.

Buffett himself, from 1957 to 1969, compounded at 29%. Munger was at 19.8%.

A friend of theirs, Rick Guerin, is famously referred to because he got over leveraged at one point in the 1970s and had huge drawdowns. What people do not talk about is that Rick came back.

Before leaving the money management industry, from 1962 to 1983, he compounded using the same principles we use in small-cap deep value at 32.9% despite a huge drawdown because he used too much leverage.

When you look at Brandes, which does small-cap international investments, just over the last 5 years they have compounded at 23%.

Look at the career of John Templeton, who was one of the first global international deep value investors. For decades he compounded at over 16% a year, and he had a big mutual fund with all the accounting, problems, fees, and expenses that go with that.

Some of the biggest winners of my career have come from using a small-cap deep value approach.

One of my favorites is John B. Sanfilippo & Son. JBSS is the stock symbol. We found them in a stock screen when the stock was $16 or $17. Nobody cared about them. They were in the nut business: almonds, cashews, and nuts that they packaged up and sold in grocery stores. That stock eventually went to $100 and $120.

There was one of my very first successes: Green Tree Financial back in the 1980s. They had taken some non-cash charges related to their manufactured housing or trailer park financing arrangements, and the stock got down to $6 against a book value of about $11, as memory serves.

A few years later, maybe seven or eight years later, it got taken over at $33 a share.

More recently, Sterling Construction. We stumbled on that one trading at ridiculously low multiples of the cash produced by the business, the cash held by the business, and the value of the assets of the business.

In 2019, we put out an aggressive buy recommendation to all of my readers at about $12. I got a letter from a reader the other day who said he bought a couple thousand shares, made over half a million dollars, and just wanted to say thank you. That stock today is about $400.

Builders FirstSource, recommended at the same time, has been a bit of an underperformer. It only went from $11 to $210. S

Then there was Green Brick Partners. That was about three weeks after those two. I recommended it at about $8 because it was undervalued on an asset basis and is now at about $80.

Argan went from $44 to over $100.

I can provide examples all day of where we spotted small companies off Wall Street's radar screen trading at steep discounts to tangible book value with strong credit profiles. They did not all go up right away. In fact, many of them went down right away. But many of the soared to several multiples of the stock's price

We also had numerous that were taken over at premium to the price we paid for our shares.

Small-cap deep value works. It actually works better than just about anything else out there. The margin of safety will take you through bad markets much better than momentum strategies. Momentum strategies have crashes. Small-cap deep value usually does not, and these stocks lead the way out of a big market bottom.

We will talk more about how to make small-cap deep value and small-cap momentum work together using the work of Cliff Asness and some other researchers. That combination is quite spectacular. But small-cap deep value with 2 margins of safety and an international outlook (where we are not afraid to go to Latin America, Europe, or Asia; if the bargain is there, we are going to pursue it) can make us an enormous amount of money.

That twin margin of safety, where we pay attention to what the business is worth and what the credit profile of the business is, and we only care about the price in relation to the asset value, means if we can buy it at a discount, we are just going to buy it. Someday, something good is going to happen to that company. Odds are something good is going to happen, and it is probably not ever going to go out of business or suffer destruction. If it is, our indicators will pick that up and we will exit the stock.

Small-cap deep value is the favorite of all my children, or at least all my market-based children. It works. It has always worked. It does not scale. It does not work for large mutual funds, large hedge funds, or ETFs. It is never going to put you on television. It is never going to make you famous. You will never be in Barron's or The Wall Street Journal. And I am okay with all of that because, honestly, I just want the inherent rates of return that come with this strategy.

That is the Flagship Small-Cap Deep Value Portfolio. I hope you use it well, and we are going to continue to talk about the portfolios and ways to make them work together as we move forward. Thanks for being part of the adventure.

Here’s the Small-Cap Value portfolio, updated as of 2/3/2026: