Smaller company investing doesn't always get the best reputation, for every ten-bagger stock pick that makes an investor the toast of the town, there are horror stories of frauds uncovered or red flags missed.
But I think there are some rules of thumb that can help an investor navigate the often choppy waters of small cap investing and turn the little acorns into giant oaks.
Many of the most important considerations centre around the person you are investing in, we like proven entrepreneurs with track records wherever possible, and the second consideration is that the entrepreneur in which one is investing owns a material amount of the company.
The chosen entrepreneurs must have real skin in the game, they must risk their own capital and not just play with other people’s money, otherwise known in markets as “opium” (OPM).
Ideally, they should hold up to 20 per cent of the equity, but no more so they don’t develop imperialistic tendencies.
Too much control is almost as bad as not enough. They must be totally committed, not just involved. Think of bacon and eggs, the chicken is involved, but the pig is committed. We’re after the pig. A sizable shareholding does not of course guarantee that things will never go wrong, as invariably they do, but it ensures that the entrepreneur leaves no stone unturned in his quest to fix things.
Knowledge gap
Only invest in businesses you understand. If you don’t understand a business, you won’t be able to value it and, if you can’t value it, you can’t raise the funds to grow it. Price discovery is the key and understanding the business model and how it generates cash unlocks it in future years.
Certain phrases, when deployed by companies, should raise alarm bells. Two of those are "land grabs and "total addressable markets", as neither of those metrics are particularly focused on profit generation, instead prioritising, or talking of, the number of customers one could attain with a product, without focusing on whether the product can be delivered to that customer at a price point which generates a return for the investor.
The previous low interest rate world led to a plethora of businesses being able to raise capital based on future vision, global domination and other gobbledygook, with free money gone and higher interest rates here to stay, go for cash generation and the here and now.
The best investment is one which pays a progressive dividend twice a year. Don’t over-concentrate on ESG (Environmental, Social & Governance) and DEI (Diversity, Equity & Inclusion) issues at the expense of the core.
Profit with purpose has been at the heart of every decent, long-lasting business built since time immemorial. Look after your employees properly and they will look after your customers well, which in turn will produce good returns for your shareholders. Twas ever thus, though many try to now present these principals as though they are new.
