- The Washington Times - Friday, November 20, 2009


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.

Q: Valuation metrics and the like aside, how should we think about microcap stocks when looking at their businesses? After all, some of these companies can be in the early stage of their business.

A: Inflection points, or moments of dramatic change, especially in the development of a company, industry or market, can provide key entry points into a stock. Some obvious inflection points include regulatory or patent approval of a companys product, a significant enhancement to the management team, distribution and/or product line, the settling of a potentially devastating law suit, winning a key law suit, etc. Any one of these events could portend sudden new traction to a companys business, leading it to higher revenue and/or even enhancing its appeal as an acquisition target, either of which tends to lead to higher stock prices (if youve bought the stock at an attractive price to begin with).

Less dramatic and immediate are inflection points such as a company beginning to realize meaningful operating leverage, meaning revenue growth is outpacing operating costs.

Q: Any quick rules that investors should keep in mind when investing in microcap stocks?

A: There are some “dos” and “donts” of microcap investing - the “Rules” as it were. If you want a real chance to make above average returns on such stocks, you just have to be smart and disciplined - and have a plan. That said here are my rules: do diversify; dont be a market timer; do dollar-cost average both in and out of a microcap stock position; dont be greedy; dont be penny-wise but pound-foolish; and do pay attention to both company and industry news.

*Chris Versace is director of research at Think 20/20 LLC, an independent research and corporate access firm based in Reston. He can be reached at cversace@washingtontimes.com. At the time of publication, Mr. Versace had no positions in companies mentioned. However, positions can change.

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