OTC Adventures with Dave Waters, Alluvial Capital (Episode 9)

Episode Summary

Executive Summary: Brandon Balo interviews Dave Waters of Alluvial Capital and OTC Adventures about his path into value investing, his microcap and dark-stock strategy, and the mechanics of building a fund around illiquid, overlooked securities. Waters emphasizes deep fundamental research, management quality, balance-sheet strength, patience, and disciplined execution in thin markets.

Main Topics: Origin story and tilt toward value investing (Priority: 5/5): Waters explains how his interest in investing began after witnessing UPS stock appreciation through his father’s career savings and during the dot-com era. He later gravitated toward value, small caps, and illiquid securities after studying finance and academic research. Launching OTC Adventures as a public research platform (Priority: 5/5): He created OTC Adventures in 2012 to publish independent research, relieve frustration with his day job, and build credibility as an analyst. The blog quickly attracted readers, some of whom became early clients and helped seed his firm. Transition from blogger to fund manager (Priority: 5/5): Waters describes how reader relationships and inbound interest in his strategy led to managing separate accounts and eventually launching Alluvial Capital. He frames the move as a mix of timing, luck, and persistence, with SMA structures useful early but less scalable long term. Investment philosophy for microcaps and obscure businesses (Priority: 5/5): His process favors overlooked but fundamentally sound small companies, not distressed turnarounds. He looks for profitability, reinvestment quality, industry context, ethical management, and capital allocation discipline before valuation. Balance sheets, operating trends, and compensation scrutiny (Priority: 4/5): Waters stresses cash reserves, manageable debt, improving margins, and sensible compensation structures. He rejects one-size-fits-all compensation rules and instead evaluates pay relative to business model, margins, and incentives. Liquidity, position sizing, and trading discipline in illiquid names (Priority: 5/5): He explains how thin volume changes entry and exit tactics, requiring patience, staged buying, and sometimes accepting wider spreads. He also warns against anchoring and premature refusal to sell when thesis risk increases. Dark and gray stocks, global opportunities, and social media (Priority: 4/5): Waters outlines how non-SEC reporting 'dark' stocks can still be researched through OTC Markets, shareholder requests, and direct company outreach. He also highlights international microcaps and Twitter/FinTwit as major research and networking tools.

Key Arguments: Overlooked small and illiquid companies can offer superior long-run returns because institutional investors and analysts largely ignore them. Successful microcap investing requires patience; many ideas take years to converge to intrinsic value. Management quality matters more in small companies than in large caps because leadership changes can rapidly alter the business trajectory. Balance sheet strength is crucial even in bull markets because liquidity and optionality matter in downturns. Capital allocation and compensation structures reveal whether management is aligned with shareholders. Not all cheap stocks are attractive; many seemingly distressed names are cheap for good reasons, especially in late-cycle environments. Dark stocks can be researched through alternative channels, giving diligent investors an information edge. Liquidation, buyouts, or special dividends can produce large one-day gains, but only after long periods of inactivity. In illiquid names, execution is part of the edge; investors must accept that bid/ask spreads and sparse volume shape outcomes. Anchoring to prior sale prices can cause investors to miss the best exit or entry opportunities.

Data Points: Launch of OTC Adventures: 2012 - Waters launched his blog to publish research on small, overlooked stocks. Initial capital for launching separate accounts: about $2 million - He started managing separate accounts in early 2014. Separate account pricing for smaller accounts: 2% under $100,000; 1.5% from $100,000 to $1 million; 1% over $1 million - Waters described his early asset-based fee schedule. Target starting period for business test: 2 years - He planned to try managing money on his own for two years before returning to a bank job if needed. SMA scaling threshold: 50 to 60 accounts - He noted separate accounts become administratively burdensome past this level. Portfolio exposure to dark stocks: about 5% - Waters said dark stocks currently represent roughly 5% of the portfolio. Trade volume in some microcaps: 1,000 shares a day or none for a month - Used to illustrate extremely thin liquidity in some holdings. Example debt cost in rural telcos: about 4% - He cited cheap debt financing for some small regional telecom companies. Example acquisition yield: 15% to 20% cash flow yield - He said acquiring competitors at these yields can be highly accretive. Reporting threshold for SEC filings: 300 shareholders of record - Below this, companies may file Form 15 and stop regular SEC reporting. Typical dark-company annual report length: 5 to 10 pages; one example 168 pages - He contrasted ordinary dark-company reports with one unusually long report from an Ohio industrial company. Example misappropriation of profits: about 90% of profits siphoned - He described a dark company where management extracted most of the economics via consulting and related-party arrangements. Horizon Telecom buyout price: $350 per share plus a $10 escrow - Waters cited a dramatic takeout of a rural telecom he had researched. Horizon Telecom share count: about 400,000 shares - He noted the company was very small and thinly traded.

Pivotal Quotes: "If you are willing to be patient and be diligent and do good quality work and put it out there, you will get noticed." — Dave Waters: On why publishing research online can lead to career opportunities and investor attention. "If the conversation ever becomes focused on fees, you've already lost." — Dave Waters: On how he frames client conversations around value proposition rather than price. "One day I will wake up and something great will happen." — Dave Waters: Describing the 'one-day stock' phenomenon in illiquid microcaps that can reprice sharply after long dormancy.

Implications: For investors, the episode argues that microcaps and dark stocks reward patience, skepticism, and deep due diligence far more than trading speed. For the industry, it highlights how information gaps, illiquidity, and poor incentives create persistent opportunity.