Investing in microcap companies provides investors with the opportunity to invest where the big institutional players can’t. By finding small companies before they start to receive analyst and institutional coverage I believe you can earn returns that beat the overall market. First, let’s define what a microcap company is.
What is a Microcap Company?
Microcap companies are very small companies with a market capitalization of under $300 million. Market capitalization is calculated by multiplying the outstanding shares in the company with their share price.
CO2 Gro Inc: 76,302,555 shares outstanding x .41 cents= $31,284,047
(You can check out my write up on CO2 Gro Inc. here.)
Microcap Club and Ian Cassel
Ian Cassel is the founder of Microcap Club. He has been investing in microcap companies for years and started a microcap investing forum called Microcap Club. In the following video, he summarizes his reasons for investing in micro caps.
At the eleven minute mark, Ian provides data on annual equity returns in the United States ranked by market cap size and liquidity. The data shows that from 1972 to 2009 small, illiquid companies provided the best annual returns at 17.87%. This is the area of the market we want to invest in.
The Boole Microcap Fund recently published data that concluded that microcap companies returned 16.14% annually compared to large-cap returns of 11%. This data was for the years 1927 to 2015.
What Does Liquidity Mean?
Liquidity describes how quickly an asset can be bought or sold without affecting your assets value. Cash is considered the most liquid asset because it can easily be converted into other assets. Your house, for example, would be an illiquid asset. It is difficult to sell your house quickly and get the cash in your hand.
In the world of stocks, an illiquid stock would be a stock that trades in a low share volume. A low share volume in combination with a low float (the number of shares that are on the market to be traded) leads to an illiquid stock. If an investor holds a large number of shares in a company and is unable to sell those shares for lack of buyers it would be an illiquid asset. Also if in order to sell their shares they have to continually accept less money for each share, then that stock is illiquid.
Why Do Institutional Investors Stay Away From Microcaps?
First off, let’s define what an institutional investor? Institutional investors are organizations that trade securities in a large enough share or dollar amount that they qualify for preferential treatment and lower commissions.
Examples of institutional investors are hedge funds, pension plans like OMERS, mutual funds, banks, and other large organizations.
Institutional investors simply have too much money under their management to invest in microcap companies for multiple reasons: there is a lack of liquidity in the stock, the fund or pension plan has rules that prevent them from investing in small companies, the company does not produce enough revenue to garner their interest, and in order to take a meaningful position they would end up owning the entire company.
The lack of institutional investors creates an opportunity for microcap investors to scoop up quality companies at reasonable valuations.
So What Are The Advantages of Investing in Microcaps
As stated above, microcap companies have provided better returns than large-cap companies dating back to 1927. Microcaps have returned 16.14% compared to 11%. This doesn’t automatically mean that this will repeat in the future but it is a good indication that there are advantages to investing in microcaps compared to large-cap companies.
In order to beat the market, you can’t just mirror the market (meaning the S&P 500 Index or S&P/TSX). If your goal is to beat the overall return of the S&P 500 index or S&P/TSX then you must differentiate yourself from these indices. Microcap companies are not captured in these indices and are a great way to be different than the overall market.
Simply the size of microcap companies increases their chances of growth. A company with billions of dollars in revenue will have a much more difficult time doubling their revenue as compared to a company with $2 million in revenue. Using Coca Cola or Starbucks as an example there are only so many more people they can sell cans of Coke or coffees too.
Many microcap companies have no analyst coverage or institutional investors. This can lead to market inefficiencies. Investors that aren’t aware of great little companies with improving fundamentals won’t be investing in microcaps. This can lead to lower valuations like Price to Sales and Enterprise Value to EBITDA ratios.
Finding a small company that is unknown to the mainstream investing public that has strong fundamentals and a reasonable valuation can lead to market-beating returns.
Breadth of Opportunity
As Ian Cassel stated in his video there are over 11,000 microcap companies in North America that employ over 2.8 million people. Microcaps cover all areas of the economy: tech, healthcare, resources, agriculture, logistics, etc. If you have a particular competence or knowledge of a certain area there are microcap companies in that area to be researched.
Access To Management
In the world of microcaps, the ability to contact and speak with management is very important. In my recent write up of CO2 Gro, I was able to speak with Vice President Sam Kanes. I submitted an inquiry on their website and he called me back and we spoke for forty minutes about the company and their plans for the future.
Good luck trying to speak with upper management at a large-cap company. I’m sure Bruce Flatt, the CEO of Brookfield Asset Management, is a great guy and would love to chat with retail investors but this simply isn’t going to happen.
By getting answers to questions you’ve raised in your research you get a better understanding of the business and ultimately a better gauge on management themselves. Microcap management is vitally important to the success of the company. Many are founders and know the company best. The upper management team often take on multiple roles and are the chief decision makers. The success of microcap companies is closely linked to the ability of management, more so than large companies that have many people involved in important decisions.
I have only been investing for a short time but I have the good fortune to invest in a couple of successful microcaps like Good Life Networks (GOOD.V) and CO2 Gro Inc. (GROW.V). I have not had these positions for very long but their share price has appreciated and they are projected to continue revenue growth.
I feel a certain amount of pride knowing that I have found a microcap company, done the research necessary to understand their business, and ultimately made the decision to invest in them.
Finding and investing in a quality microcap before there is any analyst coverage gives the feeling of getting in before the masses do. I look forward to watching the companies I own grow and hope the share appreciates along with its growth.
Microcaps still get a lot of negative coverage. This is because most of the coverage they receive is when there is fraud or illegal activity. There are many examples of microcaps that have continued to grow and provide excellent returns for their shareholders.
Xpel Inc. is a microcap that continues to come up in podcasts I listen to. Xpel Inc. makes coatings for the exterior of cars. In early 2016 Xpel Inc. was trading at under $1.00 and closed on March 25th, 2019, at $6.16 for 616% return.
Monster Beverage Corporation is one of the best-performing stocks in the last 20 years. You could have bought shares of Monster Beverage for under $1 in early 2005. The shares closed at $54.55 on March 29th, 2019. This resulted in a 5,455% return.
Monster Beverage also provides a great example of why you should continue to add to your position if the company continues to execute on their plan. Monster Beverage doubled and tripled many times over. If you continued to invest as the company continued to execute you would have continued to add to your amazing returns.
Microcaps are becoming more of a focal point in my investing. I have positions in numerous microcaps and am continuing to look for new interesting opportunities. With thousands of microcap companies available in North America, there is no shortage of companies to research.
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I swear I proof read all of my posts multiple times but always seem to miss errors. Apologies in advance.