Its Over, page-211

Small or microcap investing has its merits and can be potentially a lot more rewarding than big cap investing. It’s a lot like watching your baby grow and grow fast, and some (e.g A2M, Wisetech) do really grow immensely and we all hope we get into a new and early A2M. While big cap mcap and sp growth has its limitations due to their size.

Advantages small & microcap investing has over large caps:

• Potential for big gains can be considerable if you get in the story early on
• Less pressure to deliver to guidance as does larger cap stocks due to absence or lack of analyst coverage
• Ability to uncover and profit from misunderstood potential growth stock due to absence of lack of coverage

But it also has considerable risks that the average investor may not have fully considered:

• Lack the financing capability that larger caps do – so may require rounds of CR/placements or borrowing from unconventional sources at high interest rates
• Perhaps only 5% ever become an A2M and the rest are dogs (although they start off as darling stars)
• High volatility and not all investors can stomach that volatility that test the nerves
• Lack of liquidity and wide spread buy/sell bid- can cause sp to drop with minimal volume
• Sp could stay range bound for considerable period due to lack of coverage and awareness of stock and its potential
• Overhyped especially concept stocks selling a promise but can’t deliver
• Poor corporate governance and watch for dishonest management or those who don’t walk the talk
• No dividends compared to larger caps, hence no income
• Failure to take profits because of tax considerations [ common mistake ]
• Tend to underperform larger cap stocks during recession and/or stock meltdowns [ people tend to forget that while microcaps can become baggers , they can also be sold down up to 90% from their highs after exuberance has evaporated]

To thrive and survive in the small and microcap environment, obviously careful stock selection, weighted entry and exit point decisions and appropriate risk management are IMO key elements for success.

Careful stock selection requires some due diligence on the nature of the stock you buy. And in the small and microcap space, they are all like Disallowedmen selling you a promise and you need to discern carefully and that requires some due diligence.

• Company’s track record ( revenues first, cashflow, expenditures, share base, customer base, product awards)
• Management ( % holding skin in the game, trustworthiness assessment (I avoid some nationalities) )
• Presence of key driver to be successful in the market (e.g value proposition , differentiation, disrupter, product differentiation or first to go to market)
• Revenue Model ($ size of deals and how long it takes it close and implement a deal, recurring revenue model, scalability, global or local model, monetisation model)
• Industry that it is in (competition, regulatory difficulties)
• Ratios (market cap/revenue, EBITDA margin, profit margin)
• Is the business too difficult for an average investor to understand and therefore participate?
• Is the company making lots of announcements (especially MoUs, collaborations etc) all designed to spruik the sp in the short term?
• Potential for dilutive CR in the near term, is company running out of cash?
• Any inconsistencies in reporting or announcements or lack of announcements?
• Escrow share releases that can flood the market
• Frequency of CR/placements in the past
• Liquidity in shares traded

Weighted entry and exit points can be the deciding factor in whether you gain or lose in a trade or investment. With small and microcaps, sometimes you can make lots of money getting in early on the ride as your stock becomes a darling concept stock and selling at its high before it turns out to be a dog. BUT only if you sell before it becomes the dog and for most, greed gets in the way (you didn’t dream you could buy a car with an original $5k investment but then it got better you start dreaming of a house).

• Buy the story early or not buy at all if you are late [ procrastination doesn’t help if it is a great stock scaling higher, I don’t chase buying lower for one or two bids and missing out]
• Time to sell when stock doesn’t seem to deliver to expectations and when chart looking to progressively move lower before it becomes a falling knife chart, especially when key technical support is breached on high volumes. Stop losses are important and failure to cut loss can often lead to greater losses. Can always buy back when it drops further or have the guts to admit you were wrong selling and buying back at a slightly higher price
• Most important to take profits when you have them, or retrieve capital and leave profits to ride for remaining sessions – that de-risks your position.
• We can never always be right nor wrong but always important to admit mistakes and rectify while you can. As long as entire portfolio does well, it is ok having a few big winners and several dogs. But small-cap investing is getting a couple of jackpot winners and minimising exposure of losses on your dogs.

Small and microcaps are pretty much domain of retail investors and so psychology as is exuberance is all important in the game – when there is stock meltdown, they are the ones more susceptible to big falls than large caps and more likely to have greater difficulties recovering (most don’t ever recover to their original sp levels).

• So getting out when you see smoke (before it becomes fire) is part of risk management in small cap investing.

Finally Risk Management. Small or microcap investing to some is like a casino. But some play like it’s all or nothing. A hundred thousand on the number 0 on a roulette roll instead of spreading out the chips. Over exposure on a single stock and there are many with a few hundred thousand on a single stock, can be extremely rewarding but people could also lose it all. To recover back a big loss would be extremely difficult in today’s trading environment so it is best to avoid such circumstance. Small/microcaps have very high risks but it is commonly difficult for people to manage when the sp continues moving north unabatedly. And double down on a falling knife ex-darling stock is just as dangerous as doubling down as the stock moves up and getting increasingly more expensive. With small/microcaps, the trend is your friend is very apt as is a bird in hand is worth two in the bush.

Good luck with your investing.

All expressions above are just my opinions based on my experiences and not intended as advice and can differ based on individual circumstances.