Canary Capital have strict investment criteria for the companies...

Canary Capital have strict investment criteria for the companies that it supports and promotes to its client base.

Our due diligence process is thorough, and when we lack expertise in a certain field we will engage with consultants to advise us. Alternatively we avoid the investment altogether (i.e. we stay inside our circle of competence.)

Thorough due diligence may limit the number of investment opportunities available for clients. However it serves to improve the risk/reward metrics of Canary Capital’s investment opportunities. During our due diligence process, we look for 5 key pillars we believe must exist for a high growth opportunity.

PILLAR 1 – A CLEAR BUSINESS STRATEGY

PILLAR 2 – SUCCESSFUL MANAGEMENT

PILLAR 3 – SCALABLE BUSINESS MODEL

PILLAR 4 – LONG TERM IP PROTECTION AND / OR SIGNIFICANT BARRIERS TO ENTRY

PILLAR 5 – SIGNIFICANT INVESTMENT UPSIDE

Even if a company ticks 4 of the above boxes, it all becomes irrelevant if the price an investor pays is too high. The lower the entry price relative to the company’s true value, the greater the upside in the event of the company succeeding and the lower the downside in the event of the company failing. The opposite also holds true, if the price paid is too high relative to its valuation then investors are exposed to greater risk on the downside in the event the company does not succeed and will receive less reward if it does. It goes without saying therefore that, all things being equal, it is better for investors to select companies with the former attribute rather than the latter.

This concept is commonly referred to as investing in stocks with favourable ‘risk-reward ratios’. In value investing circles, this is also referred to as ‘investing with a margin of safety’, the margin of safety being the difference between the price paid and the investors assessment of the fair value of the company. The greater the margin of safety, the more favourable the ‘risk-reward’ ratio is. There are no hard and fast rules when it comes to determining what the right risk-reward ratio (or margin of safety) is. It will largely depend on the nature of the company’s activities and the industry that it is operating in. For Canary to do this, markets have to be less than fully efficient, otherwise it would be impossible to invest with a margin of safety (because all stocks would always be trading at fair value and reflect all known information by all market participants).

Canary Capital believes markets are semi-efficient and therefore the potential for mispriced securities do exist. There are several factors that determine mispricing and therefore the potential attractiveness (or unattractiveness) of publicly listed securities. Firstly, the market may simply be unaware of the opportunity, due to a lack of investor relations and marketing activities by the company. The market may also view a certain sector, commodity or particular company in an overly and irrationally optimistic or pessimistic light.

Other factors of mispricing may be due to the size of the company. Generally, the smaller a company is the less likely it will be receiving research coverage from analysts at established broking firms. Furthermore, smaller companies may also lack liquidity in their shares which means it is more difficult for institutional investors to take a meaningful position in the company relative to their funds under management.

In consideration of everything listed above, the team at Canary Capital have spent many years developing the skills necessary to identify investments that are being overlooked and therefore mispriced by the market. Because Canary specialises in micro cap companies, the sheer number of potential opportunities (and potential pitfalls) that exist are greater than for those who specialise in investing in larger companies.

By being vigilant with due diligence and ensuring a good entry price, Canary Capital strives to ensure the best possible risk/reward characteristics for the investments it recommends to its client base.