Mathieu Martin |

The great challenge of a microcap investor

What do you think is the biggest barrier to success as a microcap investor? Several answers certainly come to mind: a busy schedule, the lack of capital or financial knowledge, an underdeveloped network that doesn’t bring good opportunities to your attention, etc. In my own experience, it is certainly devoting the necessary time that has been the biggest challenge. The other reasons listed above can be overcome with time. Indeed, with patience and perseverance you can learn about finance and how to value companies, attend some networking events to develop your network and ultimately make your initial capital grow, even if you don’t have much to start with. Everything is a matter of time and unfortunately time is a limited and scarce resource.

In this series titled “The self-taught investor”, my goal is to share thoughts and advice to hopefully help you become better investors. I strongly believe that success is within everyone’s reach, provided that they put in the necessary efforts and have access to the right resources. Some aspects of investing require significant amounts of time and those are the ones I believe you should pay the most attention to:


  1. Research and due diligence

As a long-term investor, this aspect is the most important to me when I consider investing in a new company. My due diligence is performed in several steps, depending on my level of interest for the company. I can get a rough idea of how much I like ​​a company in less than an hour by looking at the most recent financial statements, the latest press releases and investor deck.

When I like this general overview and I want to learn more, the real work begins: deep research of the financial statements (usually for the last 3 to 5 years), analysis of the industry and competition, contact with management, discussions with other investors, financial modeling, etc. Since my strategy often involves investing in securities that are very illiquid, I try to make few investment decisions but they need to be extremely high quality.


  1. Monitoring of your portfolio positions and watch list

I run a pretty concentrated portfolio — my goal is to own 8 to 12 of my best investment ideas at any given time. Each stock therefore represents a relatively significant percentage of my holdings and must be monitored closely. I use some tools such as Conference Call Transcripts and message boards to stay up to date on the companies in my portfolio as well as those on my watch list.

When you’re dealing with microcaps, many surprises can occur: the announcement of a major contract, an unforeseen lawsuit, surprisingly positive or negative financial results, the announcement of a share issuance, etc. These events can move the price of a stock violently upward or downward and it’s the reason why you need to pay attention at all times. These news are usually communicated outside of market hours, so you have to be especially vigilant in the morning before the markets open to see if any new information was published.

Portfolio monitoring does not require huge amounts of time but rather diligence in keeping up with the latest developments. If your research and due diligence were carried out properly at the outset, the revaluation of an investment thesis following important news should be done quite smoothly.


  1. Finding new investment opportunities

Because few professional analysts cover the microcap universe, the amount of fundamental research on companies is almost non-existent. The self-taught investor must carry out his own research in order to find the hidden gems out there in the market. The more you analyze companies, the more likely you are to uncover one that has great potential. As Peter Lynch once said it: “The person that turns over the most rocks wins the game”. A good watch list comprised of 40 to 75 companies is in my opinion a good starting point in order to restrict the large microcap universe to a manageable level for an individual investor. This list will be updated as you discover new companies on message boards, by using paid resources such as the Smallcap Discoveries investment newsletter, by using stock screeners or by talking with other investors in your network. Some investors that I know will even go as far as reading all the new documents published on Sedar every day so as not to miss anything. Imagine the time required to keep such a watch list up to date!

Active investment management

The level of commitment required to do enough research and due diligence in the stock market is high, especially in microcaps where there are fewer eyes to scrutinize companies. There is a need for extra caution and thorough analysis to ensure that you understand what you are investing in.

The lack of time of many investors is probably what has contributed to the dramatic rise in popularity of Exchange Traded Funds (ETFs) in recent years. Why worry about doing all this research when you can buy a well diversified basket of securities with low management fees? ETFs are indeed an attractive option for the investor who has limited time and wants to get a return that will be similar to that of the market in general. Unfortunately, such a strategy has little chance to outperform and reward you with better than average returns.

Also, ETFs are very uncommon – or even non-existent – in microcaps (especially for very small companies). To take advantage of the exceptional opportunities that lie in the microcap universe, I believe that active management, either by oneself or through a portfolio manager, will continue to be the best way to benefit from this asset class.

So, are you ready for active management?