The Time Machine

Back to the Past: a roll-up business with a large growth runway ahead

Time Travel

What if I could take you back to April 2020? Not for the reasons you might think. Those were difficult times for many if not all of us. Lockdowns spreading across the globe, a strange, new disease that appeared to be uncurable with an unknown death rate. The future was filled with uncertainty of how we would get past this period, perhaps the disease was overblown, but in the meantime governments and caution held sway and everyone’s lives were temporarily turned upside down.

In the investment world at that point, equities had fallen across the board. Few, if any, had escaped the erosion of capital by a double-digit percentage. But, as Buffett recommended, being greedy when others are fearful, was again a good approach to take at that point. Many stocks were beaten down by even more than the index averages. At the lows for the S&P 500 around April 8 the market had dropped by 18.5% to 4983, from the previous highs of 6111. Certain stocks fell by multiple double-digits including many small caps.

To pick an example, RCI Hospitality fell to a price of $7.23 from a previous high of $25.05, a fall of over 70%. Giving it a market cap of $67 million at that point, a reasonable analysis would put the forward earnings valuation somewhere around 2x–2.5x for a growing business. Rolling up adult entertainment and food venues it looked at that point to be a business that would be critically injured by the shutdown of the physically present economy in 2020. But an investor with an eye to safety would have observed they had enough cash and financial resources to weather even an extended period of shutdowns.

With hindsight, a good investment. How about we set the dial on the time machine back a little further to Feb 1, 2004. At this point RCI Hospitality had about a dozen clubs, was around $50 million market cap and was just starting to prove that its business model worked and that it could roll up local operators. Back then it traded for $2 a share. Investing through the market’s ups and downs since then to the 2022-2023 period would have afforded the investor a 40× return. Or annualized, 20% per annum for a period of over 20 years.

It’s important to look back sometimes to be able to look forwards, so that we can try to switch hindsight into foresight. Out there is a business somewhere that will 40× in the next 20 years, and many others that will do that more quickly. Looking back allows us insights into which ones we may have overlooked or missed. Many have commented (correctly) that small caps and smaller valuation stocks give a rich fishing ground for these kind of ideas. And it is also striking that these kinds of returns are not exclusively found in overlooked, loss-making, turnarounds, or special situations. Often they are businesses that were successful, profitable, and just kept on operating and performing.