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The Smallcaps Imperative

Dear Investors,

This is a website that is dedicated to the exciting world of small listed (or soon to be listed) companies anywhere in the world. Not just any small companies, but exciting ones, offering potentially large, sometimes even amazing returns for investors.

Our investment philosophy: the smallcaps imperative
Good returns can be earned through investing in companies which enjoy a significant competitive advantage, that is, companies that can do something the competition cannot match, or not at the same price anyway. Investors stand to gain significantly higher returns still if these companies operate in growing markets. However, truly dizzying financial returns are only possible if there is a combination of a significant and defensible competitive advantage, a growing market and a small company.

The whole point is, large companies, no matter how dominant their market position is, cannot easily grow much larger, rarely do large companies operate in markets that grow at breakneck speed. Witness Microsoft or Intel. They’re basically limited by the growth of their markets, unless they diversify, but more often than not this produces disappointing returns as they have to develop new capabilities, master new technologies and face new markets, that is, large companies have to learn and unlearn to reignite substantial growth, innovate their way out of relative stagnation.

Often, these imperatives are too much to ask of large companies, especially if they’re successful in their respective fields and markets. There is lack of a sense of urgency, a mindset focused on efficiency improvements and reducing costs and waste. If the companies invest in can only grow at the speed of the (well established) market, then you as an investor can only reap returns that will rarely go beyond these growth percentages. That’s why we’ll look elsewhere, to small companies operating in markets of the future, or with the capabilities that can redefine an established market.

Investing only becomes truly exciting when one is able to find this holy trinity of the investment world: a small company blessed with an important and defensible competitive advantage, facing a relatively underdeveloped but potentially huge market. I’m talking Microsoft 1985, not Microsoft 2004.

The surprising thing is, these small, innovative companies that can redefine a market are not too difficult to find. They are more plentiful than one might think!

Risk and return
However, most small companies, no matter how promising, don’t make it into the big world. For every Microsoft, there were probably tens of equally promising companies that faltered and died. Dangers are manifold. They might have wonderful technology, but the market’s not ready, or they might not do a good job designing the products, or selling them. They might move on the turf of a larger company, which feels threatened and outspends them (that’s what Microsoft did with Netscape and Corel, for instance).

Sometimes, small companies use the wrong business model, no matter how excellent their technology or product is, that can easily kill their prospects. Another common mistake is that the company tries to do everything itself, R&D, development, manufacturing, sales, marketing, distribution, etc.. It takes time to build up the necessary capabilities and resources, and more often than not, others, larger companies, could have done it better and faster. The delay provides opportunities for the competition to catch up.

This is exactly what happened to EMI, which invented the Nobel winning CET scanner, only to be caught up by GE when it tried to do everything alone. Small innovative companies are usually good at just that, innovation. Production, marketing, and distribution is an other matter.

The most significant problem is the rigorous discrimination process by which the merely promising are separated from the ones that have an outstanding chance of success. So this is a risky part of the market, but as investors know, risk and reward go hand in hand. These risks can be managed though, there are a couple of golden rules that investors must follow in order to cope with those risks:

1) Make sure this kind of investing is for you, can you stomach wild swings in some of the shares you hold in your portfolio? Often there does not seem to be an immediate reason for those swings, other than changing supply-demand factors. One should realize that, since these companies have a small market capitalization, a single large buyer or seller can often significantly influence the price.

2) Invest only a part of one’s portfolio in promising smallcaps, a part that one can lose without suffering significant consequences.

3) Diversify; buy a number of them, preferably in different sectors and/or markets. This is the most important rule, as it the one that will significantly reduce the risks.

4) Don’t fall in love with the company, although sometimes it’s really, really difficult not to. A good strategy is to look for the weak points, not only the strong points of the companies you invest in and inform yourself from as many sides as possible. Remain critical, think what might go wrong.

5) One should also be fairly active as an investor. It’s not day trading, but there can be significant swings in share prises

The venture capital logic
Despite the risks, there’s one undeniable advantage from investing in smallcaps: it only takes a single success to make up for many duds. That’s why you’ve got to have several of them. The point is, the maximum you can lose is what you’ve paid for a stock, the potential win is virtually limitless, as we’re talking smallcaps here.

This is the logic behind venture capital. They don’t have to get it right each and every time. That’s impossible anyway, success of innovating companies depend on many different things, sometimes even the most promising technologies and companies don’t make it. But as long as there are a few successes, these will make up much more of the losses of the losers. Since successes can often be spectacular, the success rate can be surprisingly low! If one has a 10 company portfolio and one of these tenfolds (which is, in the medium term, not even that much of a tall order), the other nine can go completely broke.

If you have invested all your money into a single stock, you might lose it all (especially dangerous if you invested with borrowed money). However, the more smallcaps you have in your portfolio, the larger the chance is that you will have at least one stock that will go through the roof, returning 10, 20, 50, or even 100 or more times your money, leaving you with a killer win even if all the other companies in your portfolio go bankrupt. This is the same logic that venture capitalist rely on.

And remember, large companies can go broke as well, but they can’t produce the returns of smallcaps!

Oh yeah, did I forget to mention that investing in smallcaps is very exciting?

Some more risk and reward issues
Another reason to go into smallcaps is that they generally don’t move with the market. Many investors have had the frustrating experience that their company just announced better than expected results, only to see the share price sagging as the market is in a funk.

With smallcaps, this is a lot less likely to happen. Few fund managers buy and sell to the beat of the market, there’s little in the way of index investing in smallcaps. Hence, if your company shines, it won’t get dulled by a market slump. You can improve those odds by smart investing, and that’s what we’ll try to help you with.

We’re doing some searching for you, we’ll only select those companies in which we see true, large potential. There are too many nifty sellers in this world that take advantage of the uninformed investor. One can do that a couple of times, but this does not build a credible website. We know that we will be wrong, occasionally, but we truly believe in the stocks we recommend. We know that if you profit from the stocks we recommend, our site gains in credibility and readership, creating a virtuous cycle of trust. We’ll also expect to offer you private placements at significant discounted values.


3 responses so far ↓

  • 1 Update EFUT: accumulate // May 9, 2008 at 8:44 pm

    […] The Smallcaps Imperative […]

  • 2 Darcy Patten // May 16, 2008 at 11:15 pm


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  • 3 Accuray offers an interesting opportunity — // Nov 8, 2009 at 10:16 pm

    […] The Smallcaps Imperative […]

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