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How to find a microcap investment idea ?

In this article we will explain our method for finding suitable investment candidates in the microcap space. If you are a part-time investor like we are, we recommend you focus your energy on only one market to start off. We recommend the TSX Venture, home of Canadian microcaps, where most institutions stay away making it less competitive and more prone to finding undervalued equities.

There are 1,966 companies currently listed on the TSXV as of January 31st, 2015. We eliminate the following sectors from our research: 1,425 mining, oil & gas and utilities, 45 financial services, 39 real estate and 52 shell companies. This leaves 405 companies for us to look at. These companies are in technology, life sciences, clean tech, media, consumer products, industrial products and services. From our experience, we typically find the most attractive risk/reward plays in these sectors. We should also mention that we don’t follow early stage biotech companies.

TSX Venture Listed Company Directory

If you want to be a serious investor we recommend doing a full round of the TSX Venture. By this, we mean going on the TMXMoney.com website and looking at every stock in the Listed company directory from A to Z except for the sectors we mentioned above. We like to do this exercise once or twice a year to make sure no stocks are slipping through the cracks. The first time you do this may take a few weeks or a few months, depending on the level of depth you decide to go into for each company. For example, if you pass 30 minutes on average for each stock then it will take you roughly 200 hours to get through those 405 companies. With experience, you will learn how best to use your time on each company you look at. You will learn to filter the good companies from the bad ones. For your first round, we suggest doing the following exercise for each company:

  • Reading the latest MD&A on SEDAR.com
  • Glance over the latest financial statement
  • Browse the company website. See if an investor presentation is available in the Investors section of the website.

You will notice that some companies have a very detailed MD&A. An extreme example of this would be RediShred Capital, a paper shredding franchise. Other companies, such as Xpel Technologies, provide the bare minimum in their MD&A for competitive reasons or simply to save time.

The purpose of the first round is to get a feel for each company. Try to understand exactly what it does or plans to do. Use Google and Wikipedia to gain knowledge on the industry it operates in. In the financials, we suggest looking at sales growth, gross margin percentage, the amount of overhead, working capital, equity and the number of shares outstanding. We like to put a lot of emphasis on sales growth, so if you see that revenue grew fast (30% or more), take more time to understand why, if it’s just a one-time spike or sustainable growth.

We keep a watch list in Excel with brief notes on each stock. It can be as simple as « Makes solar cells more efficient and cell manufacturing more profitable. Started commercial sales in Q1 2014. » We don’t put every stock in Excel, only the ones with an interesting product, service or technology that we think has potential for growth. We don’t mind if the company is not yet generating revenue, the point of a watch list is to follow the progress from an early stage and eventually buy the stock when we feel comfortable.

This process allowed us to find companies like Biosyent (RX.V) and Xpel Technologies (DAP.U) that stand out from the rest. When you take the time to look at each company you can more easily make judgement calls on the quality of a particular company since you can compare it to all the others you’ve looked at.

SEDAR Filings

Now that you’ve completed a first round of the market and built your watch list, you need to keep up to date on what’s going on. We like to do this by reading new SEDAR filings every day. By going to SEDAR.com, selecting Search Database – Public Company, the date of filing and leaving the company name blank, you will see all the news for that day (alternatively, you can go in the New Filings section if you are looking for documents filed today). If you select Financial Statements, you will see each company that released its financials on that day. Another website you can use for quickly glancing at any type of filing, not just news releases, is Info TSX Venture by TMX. Looking at SEDAR filings needs to become a daily routine. If you don’t feel like reading all the news releases, we suggest at least looking at the financial statements that were released. We find that financial performance is a good precursor to looking further into a stock.

New Listings and Qualifying Transactions

We like to keep up to date on new additions to the TSX Venture. The three ways to get a listing are through:

  • An Initial Public Offering (IPO)
  • A Reverse Takeover (RTO) or reverse merger
  • A qualifying transaction under the Capital Pool Company (CPC) program.

Without going into detail on how each of these work (we will reserve that for another article), it is important to note that companies who list through an IPO will appear under Recently Listed in the TMXMs listed company directory. It is good to visit that section once in a while. New IPOs will file a Prospectus on SEDAR. We suggest reading that document before buying shares in an IPO. It provides a nice overview of the company. Note that new listings with a ticker finishing with «.P» are capital pool companies and they don’t have an actual business.

A capital pool company (CPC) is a shell company that lists on the TSX Venture by way of an IPO. These companies usually have the word «Capital» in them, for example, Rodeo Capital III Corp (ROP.P). The sole purpose of the CPC is to find a suitable operating business and acquire it. This constitutes a qualifying transaction. Instead of issuing a prospectus like in an IPO, the CPC will issue either a Filing Statement or Information Circular to give details on the business being acquired. We suggest reading that document when it gets posted on SEDAR. Once the qualifying transaction closes, the company will begin trading with a new name and ticker symbol and the «.P» will disappear. To find qualifying transactions we visit Google News once in a while, using the keywords «qualifying transaction» and filtering results by date (most recent first). You can also find these transactions by reading daily Press Release filings from CPCs. You can click here to view a recent example.

A reverse take-over is similar to a qualifying transaction. It happens when a public shell company acquires a private operating business typically by issuing equity to the shareholders of the private company who then become majority shareholders of the public entity. The difference with a CPC transaction is the RTO public shell company used to be an operating business but has since deteriorated and is now dormant. It is important that the shell company has no off balance sheet liabilities at the time of the RTO such as lawsuits and disputes. It seems that reverse mergers are less common than qualifying transactions but we still suggest keeping an eye out for them by searching google news once in a while or spotting them in daily PR filings on SEDAR. An example of a company we follow that became public through RTO is Grenville Strategic Royalty Corp (GRC.V) when it merged with Troon Ventures Ltd. Click here for an article in the Financial Post about the transaction.

Forums and message boards

Becoming a member of forums and message boards is a great way to not only learn and share information about your stocks, but also develop a network of like-minded investors. Here at Espace MicroCaps, we are active members of microcapclub.com, one of our favorite place to discuss everything microcap. It is a free but private forum for serious microcap investors. There are currently 164 members and in order to gain membership you must write a 2-3 page thesis on a company that has outstanding potential. Existing members vote yes or no on your idea. You must obtain a majority of the votes to gain access. We like the fact that club members are Canadian and American. We get to share ideas from both sides of the border.

We also frequently visit SiliconInvestor.com, the following section of the site: Microcap Kitchen Canadian Stocks. This public message board is moderated by Paul Andreola (a.k.a. diddlysquatz) who has an impressive track record in picking high return stocks. The board is for discussing Canadian microcaps in the non-resource sectors.

Finally, we also visit the Swing Trader Message Board at InvestorsHub.com. The public message board is moderated by Mike Schellinger (a.k.a. MikeDDKing), another well renowned investor in the microcap community.

Stock screeners

We are not a fan of stock screeners for a couple of reasons:

  • We have a hard time finding a good screener and we are not willing to pay up for this service.
  • Even the most powerful screeners let some companies slip through the cracks. We prefer knowing as many individual companies as possible in our target market by looking at them one by one than leaving it to a screener.
  • If most people are using screeners then chances are the same stocks will be popping up for those people. We are looking for companies that typically wouldn’t pop up on screeners. We want to find truly undiscovered companies.

That being said, we still like to screen the OTC market once in a while because there are 2,166 stocks listed on the OTCQB tier (our favorite tier) and another 4,414 listed on the OTC Pink Sheet tier that are current with their reporting. We usually screen for market caps of 50 million or less, shares outstanding of less than 50 million, low P/E ratios (5-10) or low P/S ratios (0-1). We use the screener from our discount brokerage or the one from trade-ideas.com.