The Basic Tenets of Small and Micro-Cap Investing

 

  1. Diversification   Due to the illiquidity of some stocks, it is best to diversify. This is, without doubt, the most important tenant of the philosophy. This not only increases your chances of success, but also protects you against having to sell at an inappropriate time. One hopes, if chosen well, to be in a position to sell a winner.
  2. Small and Micro-Caps are More Reasonably Valued Than Large-Caps   Due to the lack of institutional following, and their reliance on retail following, small and micro-cap companies trade at multiples that are a fraction of their large-cap or “blue-chip” counterparts.  The average price multiples on the S&P 500 for large-cap companies is currently 17 times.  We often find companies trading as low as 4 or 5 times this year’s estimated earnings.  While “blue chips” are almost always priced to perfection, properly chosen micro-caps offer little downside, with their low multiples, and in fact, they can often trade significantly below their book value.
  3. Small and Micro-Cap Canadian Companies Offer Some of the Best Value in North America   Although many of these companies do up to 90% of their business outside of Canada, and often compete successfully on a worldwide scale, they trade at multiples that are a fraction of their American counterparts.  This works to our benefit because we are able to buy them at a discount. 
  4. Small and Micro-Cap Financial Statements are Transparent and Easy to Follow The extremely complicated nature of large-cap Company’s financial statements increase their ability to hide important financial information.  Enron, Global Crossing and numerous other examples, brought to light a very serious problem that persists to this day.  Small and micro-cap companies generally have, at most, two or three revenue streams and their ability to hide financial information is greatly reduced.  Furthermore, by having only a couple of income streams, it is much easier to determine if management and the company are on the right track.  This transparency is critical because it makes it easier to invest with confidence if one feels they have an accurate barometer of the company’s business.
  5. Individual Equities Offer the Greatest Potential for Portfolio Performance Having been associated with growth companies, and having experienced hyper returns, I have seen the portfolio changing experiences that can come from individual equities.  If a properly diversified portfolio of say, $50,000, were to own 20,000 shares of stock at $0.30 and that stock went to $2.50, even if the other seven stocks in the portfolio were to break-even, the portfolio on a whole would be up 100%.  The client could sell this position and net $50,000 and then use the proceeds to put another seven “horses” in the race.
  6. I Invest Large Amounts in Fewer Companies to Properly Focus on the Individual Companies  By having a concentrated position in a selection of companies, it makes it worthwhile to closely monitor those companies.  This means monitoring the quarterly updates, news releases, talking to the CEO, and making site visits.  This concentration enables me to focus on their trading patterns as well, which helps me to determine when to enter or exit a position and to identify any technical breakouts.  Ultimately, this knowledge benefits my client’s returns.  
  7. I Rely on Regular Dialogue with CEO’s to Attain Greater Insight into the North American Economy The CEO’s, many of whom are current clients, represent companies that have a combined $500 million worth of market capitalization.  These are head decision makers who must stay on top of their business environment and the trends in the economy.  It is their job to not only monitor the business landscape but also to look ahead.  I find it invaluable to have these CEO’s as clients because they are able to pass on what they see and why.  I want to make it clear; they are not passing insider information but, rather, are giving me their insight into their business environment.  This definitely is an advantage in helping to make better investment decisions.  
  8. Hang on to Your Winners …as long as possible. And, perhaps add to your position, if they are still undervalued.  Because we are buying small and micro-cap companies whose share prices can be as low as $0.25 to $0.50 per share, these companies can get on a roll.  Don’t be quick to sell or take a profit on your winners.  These companies are considered growth companies and if management has been able to position the company and it’s products/services correctly, quite often the growth curve is steep and dramatic.  Experience has taught me that often your early winners will remain winners.  If management has performed well in the past, they will likely do so in the future.  Too often, I see investors average down, which makes no sense to me. Why reward an underperforming stock by throwing more money at it?
  9. I Invest Alongside My Clients   I buy the companies I recommend. Naturally, I follow them closely.  When a stock moves up or down and a client asks, “what should I do?” I honestly tell them what I recommend and why I feel that way.  I make them aware of all pertinent news and information in order to help them make a proper and informed decision. 

Where will your investments take you?