Bottom fishing, made popular by value investors like Warren Buffett and Benjamin Graham, is a strategy focused on buying low-priced stocks that have dropped significantly. The idea is simple: buy stocks that are trading at a deep discount with the hope that they’ll rebound. The Bowser Report applies this strategy in many ways, including awarding a Bowser Rating point to stocks trading at 50% of their 52-week high or lower. When executed properly, bottom fishing can yield great results, but it also comes with considerable risk, especially in the small-cap world.

Risk and Reward

Bottom fishing is inherently high-risk, and that risk amplifies when dealing with small stocks. Smaller companies are more vulnerable to delisting and often lack the financial resources to weather market volatility. Despite this, small stocks can deliver outsized returns because of their growth potential.

Investors should buy a stock when it has the highest chance of appreciating and not aim for the exact low. Market conditions, underlying value and  current price are all factors in how likely a stock is to bounce. The following example shows the difference between trying to buy the bottom versus bottom fishing:

Out of the two stocks, most investors would rather buy Stock A over Stock B. Stock A is trading at a lower price, it is down further from its 52-week high and it is trading near its low.  The psychological issue at hand with buying Stock A versus Stock B is greed. Investors focus on the reward instead of the risk. However, the buying pressure for Stock B gives it a higher probability of
having found a bottom than Stock A. Therefore, while the reward may or may not be lower for Stock B, the risk of taking a loss is likely lower.

Signs of a Bottom

Finding bottoming stocks is easier during a bear market that has lasted for six months or longer. Even though we are no longer in a prolonged bear market, there are still opportunities to buy discounted stocks. The first step is to find stocks of interest and then recognize the signs of a bottom.

Two key indicators to look for are future earnings growth and price-to-book (P/B) ratios. A positive outlook for earnings and a historically low P/B ratio suggest that a stock is more likely to have hit a long-term bottom. Take Daktronics (DAKT) as an example. In April 2022, DAKT’s P/B ratio hit a new low of 0.75. Despite a decrease in book value over the next two quarters, earnings forecasts were strong. By December 2022, the stock had sold off aggressively, hitting a low of $1.46 per share before rallying 750% over the next eleven months.

The strategy here wasn’t to buy the absolute low but to enter as shares began recovering. Attempting to time the exact bottom could have led to a 50% loss before the trend reversed.

The Bowser Game Plan

The Bowser Report has a clear set of guidelines for bottom fishing and investing in small stocks:

  1. Do not pay more than $3/share for a stock.
  2. Build a portfolio of 12 to 18 stocks. Diversification is key to managing risk.
  3. Do not sell when a stock rises above $3/share. Hold onto it as long as it continues to perform.
  4. Sell half your holdings when the stock doubles. Sell the remainder if it drops 25% from its most recent high, or sell all if it drops 50% without doubling.
  5. Track and record proceeds from sales. This ensures you evaluate your portfolio properly.

This disciplined approach helps minimize risk while maximizing long-term gains. It ensures that investors don’t make emotional decisions based on temporary price movements.

Market Valuation and Stock Picks

The market often values these discounted stocks at lower prices for a reason. To succeed in bottom fishing, investors need to focus on probability over luck. Stocks with positive earnings forecasts and relatively low P/B ratios are prime candidates. Current examples include American Shared Hospital (AMS), ARC Document Solutions (ARC), Better Online Solutions (BOSC), and Good Times Restaurants (GTIM). All these stocks have positive earnings forecasts and low P/B ratios.

Price Patterns: Recognizing Strong Lows and Bases

Technical analysis plays an important role in identifying when a stock has bottomed. A strong low is one of the most reliable signals of a reversal in investor sentiment. For a stock’s price to form a strong low, it must follow this pattern:

  1. A sharp selloff without any strength.
  2. A sharp rally that doesn’t revisit the low.
  3. The stock recovers 50% of the prior selloff.

This pattern indicates that the market sentiment shifted quickly and, combined with positive fundamentals, it suggests the stock won’t revisit its low before making a substantial rally. Daktronics' (DAKT) rebound in December 2022 is a textbook example of this, with the stock rallying sharply after a major selloff.

Another key pattern to recognize is the formation of a long-term base. While bases take longer to develop, they often reward patient investors. A base forms when a stock’s price pulls back but does not close lower than its prior monthly low for consecutive months. For example, Superior Drilling Products (SDPI) formed a base when it retested its lowest monthly close of $0.67 in November 2023 but did not close lower for consecutive months.

This signaled that selling pressure had subsided, and buying demand was returning.

Conclusion

Successful bottom fishing combines a mix of fundamental analysis and technical pattern recognition. While oversold stocks with good Bowser Ratings may be tempting, it’s essential to consider other factors like strong lows and long-term bases to find the best entry points. Following these principles, alongside the Bowser Game Plan, will help maximize long-term results while managing the risks inherent in small-cap investing.