Why Every Investment Case Can Be True (and False)

Be careful of this, it's everywhere.

I know I could persuade someone that a concentrated portfolio of micro-cap stocks is the best way to invest.

I also would bet that I could make a concentrated portfolio of micro-cap stocks sound like the worst idea in the world.

It’s all down to how I present my information.

Entertain me for a moment, it’s important you know this idea.

Here are two arguments, one for and one against concentrated micro-cap investing:

Why a concentrated micro-cap portfolio is great:

It’s known by now that if you want to get returns that are different from the crowd, you must invest different from the crowd.

Micro-caps offer eye watering returns because this is where the crowd isn’t.

They operate in one of the most inefficient corners of public markets; under-followed and under-analysed. They have a lack of institutional interest and analyst coverage which creates a fertile ground for you to fish out undiscovered gems.

Unlike large caps, where information is quickly priced in, micro-caps often trade far from fair value; if you want to do what Buffett did to get rich - you’d be investing in micro-caps.

Research suggests this inefficiency leads to a persistent value premium, especially when investors avoid the very smallest, most illiquid names.

Micro-caps behave more like public-private equity. These are often early stage companies with significant growth potential, operating in niche markets or undergoing transitions.

You can get private equity returns all whilst having daily liquidity and no lockups. Bliss.

Add to this the fact that micro-caps are largely excluded from major indices, and you have a major opportunity: global capital ignores this segment, which only increases the odds of mispricing.

Micro-caps have a bad name because people like to focus on the unprofitable, speculative names, but there are gems - true diamonds in the rough.

If you’re willing to build conviction, concentrate capital, and hold through volatility, the payoff is substantial.

A concentrated micro-cap portfolio offers exactly what most of the market avoids: inefficiency, information gaps, and overlooked upside.

Micro-caps is where the real money is made, the 1960’s Buffett kind of money…

All it takes is a passion for turning over rocks, and some patience.

Why a concentrated micro-cap portfolio is a terrible idea:

A concentrated portfolio in this space magnifies nearly every investment risk. These stocks are volatile, illiquid, and plagued by limited financial transparency.

Historical data shows that the micro-cap premium so evident in the 20th century, has largely vanished in recent decades.

They’ve consistently fallen harder in downturns; such drawdowns can be devastating, and in a concentrated strategy, even a single blow-up can derail the entire portfolio.

Liquidity is another major hurdle. Micro-caps trade in small volumes with wide spreads and high slippage. Executing trades without moving the market is difficult, especially when the portfolio is focused. Worse, many of these companies aren’t on major exchanges, lack proper governance, and carry meaningful default or fraud risk.

Beyond the security-specific risks, the strategy fails the diversification test. Empirical research shows that such portfolios frequently suffer extreme volatility without delivering compensating alpha. They also miss out on broader market returns, especially in segments like large-cap tech or global growth leaders, which have driven wealth creation over the last 15 years.#

A heavy tilt toward micro-caps sacrifices exposure to these dominant trends and reduces portfolio flexibility when it’s most needed.

While the idea of uncovering the next undiscovered winner is appealing, the structural, behavioral, and practical risks of a concentrated micro-cap strategy are overwhelming.

Even experienced investors often find that the upside is no match for the reality of the drawdowns and volatility.

Add to this the fact that even if you succeed at it, one day you will have to learn a new strategy because you can only invest in this space with a small capital base.

Who wants to have to learn another effective strategy all over again, on top of all the unnecessary risk?

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That’s micro-cap investing framed in two different ways…

One could agree with both. But which is correct?

This kind of persuasion is rife in financial markets every day.

It’s called the framing effect, where people's decisions are influenced by how information is presented, rather than the information itself.

In the investment world, data is stretched, manipulated, and cherry picked in any way possible to suit the incentives of the presenter of information.

If I’m Vanguard, I’m going to tell you about the inevitable failure among retail investors and successful stock picking.

If I’m a fund manager, I’m going to tell you that the more people that invest in ETF’s the more alpha there is to be had in stock picking.

Everyone has a story, an incentive, and a way of presenting information to suit them.

I only need one piece of evidence to prove to you the existence of this effect in markets.

Luckily, the one piece of evidence is abundant: liquidity.

When you sell your shares, someone is buying those shares from you because they have a way of framing the information so compelling that they want the shares that you’re offloading.

There’s a bear/bull case for everything.

It’s all about how one frames the information.

So, how do we know what’s correct when there are so many ways of framing an argument?

This is a battle that’s been raging in my head for a while.

It’s hard to avoid falling victim; in the past I have read many investment theses and fallen immediately in love with it - rejecting the idea that there may be a way of framing it where the stock doesn’t look so appealing.

But relying on the conviction & research of others is lazy.

And you can’t afford to be a lazy thinker in the world of investing.

This is the profession of nuances; instead of craving black and white answers from other people, one must do the work themselves and accept the inevitable uncertainty of grey answers and proceed with the necessary caution.

The key insight lies in understanding all sides of the argument, viewing them objectively, and making your own mind up - based on the facts - as to which outcome is most probable.

If we want to do this effectively, there are three things we should consider in the face of framing effects.

Let’s run through them.

Thinking Like Karl Popper

Famous philosopher Karl Popper created a scientific theory called falsification; he argued that scientific inquiry should aim not to verify hypotheses but to identify conditions under which they are false.

Similar to Charlie Munger’s idea of inversion.

Falsification focuses on disproving rather than confirming hypotheses.

We investors would do well to implement this.

We’re addicted to seeking evidence that supports our theses, but you can’t think clearly in an echo chamber.

You need to fight your ideas.

If you struggle to disprove your own theses, someone else won’t.

Reach out to other smart thinkers and allow them to be your mental sparring partners.

Get smart people to pick holes in your argument, see if they can disprove your thesis.

It’s not an insult nor is it embarrassing to be disproved, it’s necessary if you want to improve as an investor.

Scientists see disproving a hypothesis as an advancement, we should too.

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Popper thought that however many confirming instances exist for a theory; it only takes one counter-observation to falsify it.

This should be true for us too; no matter how many great arguments for a stock, one important counter-point should be enough to turn you off.

This means we need to have very high standards. Coincidentally, this is a trait I’ve seen in many successful investors.

Charlie Munger read Baron’s for 50 years and only ever got one investment from it, that’s high standards.

Joel Greenblatt only invested in 6-8 names at any given time, that’s high standards.

The pickier you are, the more likely you are to find something that has very little chance of being wrong.

Be picky, seek evidence that goes against your thesis, test your ideas with rigour.

Make them anti-fragile.

Think like Popper.

Daniel Kahneman & Base Rates

In Daniel Kahneman’s book ‘Thinking, Fast and Slow’, there is a plethora of interesting ways to stay rational and avoid biases; one that stood out was the awareness of base rates.

A base rate is the naturally occurring frequency of a phenomenon in a population.

For example - going back to the micro-cap example - the base rate of successful investing in micro-caps is far lower than investing in large caps.

Opinions on micro-caps may be skewed by the idea that most big winners start out as micro-caps; but probabilisticly speaking, the average investor would do better staying in large cap businesses where there is a larger base rate of success.

This is why base rates are useful, they bring you back to reality.

Lots of people (myself included) will still have the misguided belief that they’re different, but it pays to know the probabilities you’re up against.

Base rates are the reality check we need when we start to get carried away.

If you think you just found the one biotech business that’s about to breakthrough, base rates would quickly snap you out of that idea.

Another brilliant thing about base rates is that it can be a wonderful place to conduct study.

Go and study the characteristics of the micro-caps that made it big; what was the situation like? Were they all profitable? Did they dilute along the way? Was there insider buying? etc..

When you know the characteristics of those successful ones, you can start to increase your probability of success.

Dealing With Probabilities

One of the most important ideas I’ve ever come across in investing was Joel Greenblatt’s views on position sizing.

It’s easy to think a stock might 10x and you want to go all in, but this isn’t thinking in probabilities.

The wiser thing to do is to invest heavily in the stock you believe you’re not going to lose money on, not the stock you’re going to make the most money on.

This is what Greenblatt did to make his money:

This idea transformed the way I size positions in my portfolio, it’s a fantastic way of minimising permanent loss of capital, which is really our main goal as long term investors.

Probabilistic thinking should flow into your analysis of investments too, not just how you size them.

Investing is about taking unfair bets; reminiscent of Mohnish Pabrai’s idea of ‘heads I win, tails I don’t lose much’.

Try to find situations where the upside and downside are asymmetric.

In a talk at google, Pabrai explains how Richard Branson created an airline business - one of the most capital intensive business models - with little to no risk.

It’s a brilliant story. Check out this clip, it’s worth your time:

Thinking in probabilities allows you to view things objectively; the way an argument is framed can’t change the probability of an outcome.

Thinking this way, you reduce the chance that you’re being persuaded of something. A 10% chance of success is difficult to paint in too many different ways.

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One of the main takeaways I found whilst digging into this idea was to never borrow conviction.

You never know how someone came to their conclusions.

You simply have to do the work for yourself, seek all sides of the argument.

Be wary of the arguments that people sell to you; its never black and white, you have to think for yourself and embrace uncertainty.

There are incentive problems everywhere and data is easily manipulated, it’s not wise to take things on face value.

We have to be careful out there, there are more opinions than facts… Hence we need to be picky with what we take on board.

In summary, seek to disprove your theses, think in probabilities, and always be careful of how information’s being framed. You never know what that persons incentives might be.

Thank you so much for reading.

Sincerely,

The Intellectual Edge