| Since 1990, David Newton has been Professor of Entrepreneurial Finance and the founder and head of the Entrepreneurship program at Westmont College in Santa Barbara, CA, prior to which he taught for five years in the MBA program at Pepperdine University in Los Angeles. He worked for two years in investment banking in Boston in the early '80's, and has been a consultant to more than 100 fast-growth emerging ventures in the areas of start-up business plans, small firm financial strategy, venture capital, IPOs, and firm valuation. Books How to Be an Internet-Stock Investor , McGraw-Hill, 2000 How to Be a Small-Cap Investor , McGraw-Hill, 1999 Entrepreneurial Ethics , Kendall-Hunt, 1997 Investing in small-cap stocks -
Today's youngsters will one day grow up! The 'big' publicly -traded firms that dominate the DJIA and SP500 were all at one time small-cap stocks. They just happened to turn into big companies over time. That same kind of growth is still available for investors willing to do the careful review of today's smaller, less-popular and less-watched firms. Granted, not every small-cap today will be a mid-cap or large-cap industry leader tomorrow, but recognising future industry potential means that dozens of today's $200M capitalization companies may one-day be $5+ billion caps when they finally hit full stride. -
See through an 'entrepreneurial perspective'. Investors have to think like an entrepreneur and view small-cap companies with the same entrepreneurial eyes employed by venture capitalists and early-stage investors. Don't look for some 'quick-fix' rapid return. Instead, nurture an entrepreneurial approach to spot solid opportunities, and then embrace a vision for potential extraordinary results. Ask questions like, "How will this firm reshape its industry?" and "Why will this company do it better than the others?" The result can often be several-fold increases in share prices for investors who gave these small 'upstart' challengers the breathing room to state their case, implement their innovation, and compete head-on with the established firms in the best industries and growth markets. -
Keep sifting that profile colander. It is imperative that investors systematically put new small firm prospects through a rigid and multifaceted review process, to continually screen the best industries for the most promising investment opportunities. Treat the external environment like a pool of interesting new ventures, each pitching their business model and management team to you for possible investment. So you'll need to keep regular incoming deal-flow in order to yield a consistent pattern of new equity investments throughout each fiscal quarter. Do this quarter by quarter, and year by year, and over time, this constant sifting will yield a nice cache of golden nuggets with extraordinary value. -
"I'll Be Watching You" - because nobody really is. Understand this! If equity markets are weak-form efficient, then your systematic approach to research, homework, interviews, and due diligence will amount to far more than most other investors and analysts do with these same small-cap firms. And the overall picture that unfolds when all the data is in will likely be quite proprietary versus the generic near-consensus that typically happens in reviewing the large-caps. Good contacts, attending trade shows, talking with industry people, tracking product and service advances over time . . . these all yield insights into the small up-and-comers where virtually no one else is doing any regular monitoring and review. So "every breath they take, every move they make, you'll be watching them", and that's what makes small-caps well worth the effort. -
Out of sight, but not out of mind. Give the small-cap stocks some time to develop their great investment flavour. Like a fine wine sitting in a cellar, or a great sauce simmering on the back burner , great taste comes with patience. Stop chasing every short- term trend that surfaces, because you'll probably end up buying after the upward movement, and selling before the peak anyway. Instead, invest systematically in an ongoing process over time, and then give these small firms ample time to put out roots, mature, and bear fruit. Just seven short years ago, those 10- foot Valencia trees in my backyard were scrawny 8-inch saplings with two leaves in a half-gallon bucket. Today they're laden with hundreds of sweet ripe oranges three times a year. You cannot rush success, and your time is wasted chasing every new 'hot-tip'. But patience cultivated over time is an invaluable small-cap investor virtue. -
Follow the bread-crumb trail to a great investment pathway . Spend time regularly reviewing the 8-10 year track record of investments made by twenty or so public small-cap stock mutual funds. What companies were they investing in 1992, 1994, and 1997? Look up those same companies today and calculate each fund's batting average, by taking the highly successful firms today divided by the total small-caps invested in over the entire period under review. Now, take a closer look at today's small-cap investments in those same small-cap funds, and target reviews for individual firms from funds with the highest success averages. It's fairly likely that many of the these small-caps will be well worth some additional homework on your part. -
Diversity is the spice of your investment life. Small-cap investing is not simply about technology companies. There are hundreds of great emerging companies across every sector of the economy, and in each of the dozens of industries that comprise those sectors. Be sure to represent numerous 'types' of smaller, emerging firms in your portfolio. A little-known manufacturer today may be acquired tomorrow by a global distributor at 6 or 7 times its current price. A tiny parts provider today could become the leader in its market niche over the next few years. And a small-cap engineering company might turn its patented speciality design into hundreds of strategic partners within five years. Good diversification across several strong industries will always provide a wider and more robust range of opportunities for company growth and share price appreciation . -
VCs live with losers. You can too! Thinking like a venture capitalist is the only way to approach systematic small-cap investing. Not every small-cap investment can be expected to provide huge returns. In fact, for every 10 firms in the portfolio, 3 small-cap stocks will most assuredly lose significant value while 4 others will probably end up in the general vicinity in which they were originally purchased, even after holding them for a long time. So deal with it; the VCs do. However, 2 other firms will perform very well over time, and 1 of those original 10 will be the star that soars geometrically ten or twenty fold in value. The expectations should be this: the net result of the combined performance on every 10 stocks purchased should be a positive return and significant, but not every individual stock will be a star performer. -
"Hey buddy, can you spare some information?" Smaller companies often do not show up on the radar in industry or consumer marketing reports . They are generally left out of the most noteworthy stock guides, or at best, have relatively little company information or news releases when compared with the 'big names ' in their investment sector. But that also becomes your advantage, because you can uncover information that is not widely known if you're willing to attend a few trade shows and product fairs, or speak with purchasing managers and company officials directly. And don't rule out a site visit to the firm's HQ. Less formal research and review may produce insights that are not common knowledge throughout the equity markets. -
Hang out with the 'players'. You've heard that 'misery loves company'. But on the flip side of that adage, 'risky opportunity loves confirmation'. One such confirmation about a small-cap that passes your own systematic screening process, is that it has also been 'approved' by larger institutional investors (commercial banks, investment banks, insurance companies, broker-dealers, pension funds). Check to see if any common shares in your target small-cap firm are held by noteworthy institutions and if so, what is their relative percentage stake among all the equity holders. If a small firm is not closely watched, but a few institutions have decided to take a position, then they must know something, either better than your information or the same thing you've uncovered. This could serve as the affirmation boost you need to hear, and confirm that your thorough due diligence is probably trustworthy after all. www.westmont.edu |