Micro Cap aint easy, and that is why most of the financial community views micro cap companies as un-investable. This negative broad brushing of a whole investment class allows irrational gains to be achieved in the few “real” value and growth micro caps that exist (because no one follows them). For a micro cap stock to go from $1 to $10 so much has to be done right by management in the beginning, and this is why most micro caps never have a chance. When you look back at some of the biggest micro cap success stories you start to see these common themes that don’t even have anything to do with the underlying business:
- Share structure: The company’s stock was very tightly held and management was very cautious of dilution. In most cases there were less than 50 million shares outstanding and less than 15 million shares in the float. The lesser total shares the more it has to move up to gain market cap. The lower the float the less volume it takes to turn the float over to move the stock up.
- Raising Capital: The company’s management was very cautious on deal terms and to whom was making the investment. A management that raises capital incorrectly dooms shareholder value in most cases. It also shows the inexperience of the management which is almost always an indicator they will do it again.
- Telling their story: Management spent the necessary time getting the word out about the company via: conference calls, conferences, road shows, etc. People can’t buy the stock unless they know you exist. As an investor I want to know that management is pounding the pavement telling the story. I have no interest in owning a public company that is being run like a private one.
A tight share structure, raising money correctly, and letting investors know they exist does not sound like rocket science but alas it is. Very few micro cap management teams “get it”, and that is why picking winners is so daunting (and we haven’t even talked about the underlying business yet). I’ve lost a lot of money taking too large of a position upfront, then talking to management thinking they understood only to be disheartened later. Now I take smaller positions upfront and buy more as management executes. What you find is all three points above blend together. For example, a company that isn’t telling the story correctly will always have a under-performing stock that will likely result in raising money at depressed prices which increases dilution. An exciting growth business combined with a management team that understands 1-2-3 will have a good chance at success. One of my next blog posts will be about picking the inflection point and buying cheap growth before it gets expensive.