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VERSACE: Mastering the microcap world
Question of the Day
One of the key points that contrarian investors make is to not follow the herd. More simply, zig while others are zag to find an investment, be it stocks, bonds, land or some other investment vehicle, that may be overlooked and as such offers an interesting opportunity. Many professional money managers, institutional portfolio managers included, tend to stay focused on larger capitalization stocks while avoiding smaller ones. It stands to reason then that “microcap” stocks may offer some undiscovered opportunities.
To help make sense of potential opportunities with very small capitalization stocks, I turned to Steve Kann, a recognized expert in microcap stocks. His experience includes more than $300 million in corporate finance transactions in the microcap/small cap space, including initial public offerings, mergers and acquisitions and private placements. He was the co-founder and editor of BullMarket.coms Bull Market MicroCap Review, and currently writes a blog titled, “The Microcap Minute.”
Q: Steve, what is a “microcap” stock and how does it compare to larger ones?
A: Some people mistake microcap stocks for “penny” stocks. While most penny stocks are microcap stocks, not all microcap stocks are penny stocks. Let me explain. By strict definition a microcap stock is defined by its market capitalization; that is, the number of shares outstanding multiplied times the stocks current quoted price. The “cap” in microcap is short for “capitalization” and the “micro” means “very small.” Everyone seems to have his or her own definition of “micro” in the context of market capitalization. Here is how I personally see it:
Large cap: More than $10 billion
Midcap: $1.5 billion-$10 billion
Smallcap: $250 million-$1.5 billion
Microcap: $50 million-$250 million
Nanocap: Less than $50 million
Q: We hear a lot about large cap stocks and how some are key to several market indices but how big is the universe of microcap stocks?
A: Good question. To begin with, there are almost 10,000 stocks traded on the various exchanges/quotation systems (NYSE, AMEX, NASDAQ, OTCBB, Pink Sheets) in the United States. Only 30 stocks make up the Dow Jones Industrial Average, 500 the Standard & Poor’s 500 and 2,000 the Russell 2000 Index. Roughly 5,000 are microcaps, meaning that to exclude microcaps is to exclude half the investable universe in the United States.
Of the 5,000 microcaps traded in the United States, it is estimated that fewer than 20 percent of them - less than 1,000 - have even a single independent sell-side analyst “covering” the stock; that is providing commentary and/or analysis on the company and recommendations regarding the trading of the stock.
Q: Part of your investing thesis for microcap investing centers on “information arbitrage.” What do you mean by that?
A: Arbitrage, broadly defined, is profit making by buying a security at a low price in one market and simultaneously selling in another market at a higher price. While Im taking a bit of literary license here to make a point, our information arbitrage is defined as profit-making by buying a security at a low price in one market, when information/insight on that security is scarce and/or narrowly distributed and later selling it at a higher price on the same market when information/insight on that security is plentiful and/or widely distributed. Please note that this most emphatically does not mean “inside information” (information not available to the public) but rather information that is readily available to those who look for it, information on companies about which very few people know exist, let alone research and evaluate.
About the Author
Chris Versace, the “Thematic Investor,” is the director of research at Think 20/20, an independent equity research and corporate access firm located in the Washington, D.C. area. Before Think 20/20, Mr. Versace was the portfolio manager of Agile Capital Management (ACM), a thematically driven alternative investment fund. The groundwork for ACM was laid during Mr. Versace’s tenure as senior vice president of equity ...
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