Chapter 14
IN THIS CHAPTER
Surveying small caps
Considering initial public offerings
Discovering motif investing
If you’re an investor (or a speculator) who wants to use a relatively small amount of money to buy stock in a single company or a set of companies (much like a mutual fund but requiring less money), this chapter is for you! Many investors dream of buying a cheap stock (referred to as micro caps and small caps) and watching it become a real investment powerhouse. It can be done, but you need to do it right; the first part of this chapter addresses this topic.
Another consideration is investing in a company’s IPO (initial public offering). The right IPO can make you a fortune, but too many people lose money because they miss some crucial points (which, of course, I cover here).
One way to potentially turn a small grubstake like a few hundred dollars into big money is through a relatively new innovation called motif investing. Motif investing gives you the ability to invest as little as $250 into a batch of stocks and/or exchange-traded funds (ETFs) that have a particular theme or a specific outlook that you expect to occur. You can get the scoop later in this chapter.
Everyone wants to get in early on a hot new stock. Why not? You buy Shlobotky, Inc., at $1 per share and hope it zooms to $98 before lunchtime. Who doesn’t want to buy a cheapy-deepy stock today that could become the next Apple or Walmart? This possibility is why investors are attracted to small cap stocks.
Small cap (or small capitalization) is a reference to the company’s market value, as I explain in Chapter 1. Small cap stocks are stocks that have a market value under $1 billion (some consider the cutoff to be $2 billion). And small cap stocks that are valued under $250 million are referred to as micro caps. (Note: Some consider micro caps to be under $100 million, and the stocks of these relatively small companies are often referred to as penny stocks. For the most part, I simply refer to them as small caps.) Investors may face more risk with small caps, but they also have the chance for greater gains.
Out of all the types of stocks, small cap stocks continue to exhibit the greatest amount of growth. In the same way that a tree planted last year has more opportunity for growth than a mature 100-year-old redwood, small caps have greater growth potential than established large cap stocks. Of course, a small cap doesn’t exhibit spectacular growth just because it’s small. It grows when it does the right things, such as increasing sales and earnings by producing goods and services that customers want to buy.
Don’t get me wrong — there’s nothing wrong with speculating in small cap stocks (of companies that aren’t proven in sales and profits). But it’s important to know that you’re speculating when you’re doing it. If you’re going to speculate in small stocks hoping for the next Microsoft or Apple, use the guidelines I present in the following sections to increase your chances of success.
These points are especially important for investors in small stocks. Plenty of start-up ventures lose money but hope to make a fortune down the road. A good example is a company in the biotechnology industry. Biotech is an exciting area, but it’s esoteric, and at this early stage, companies are finding it difficult to use the technology in profitable ways. You may say, “But shouldn’t I jump in now in anticipation of future profits?” You may get lucky, but understand that when you invest in unproven, small cap stocks, you’re speculating.
www.sec.gov
, and check its massive database of company filings at EDGAR (the Electronic Data Gathering, Analysis, and Retrieval system). You can also check to see whether any complaints have been filed against the company.www.valueline.com/
), or venues such as Seeking Alpha (https://seekingalpha.com/
) and Yahoo! Finance (https://finance.yahoo.com/
) follow the stock. If two or more different sources like the stock, it’s worth further investigation. Check the resources in Appendix A for additional sources of information before you invest.Micro caps and small cap stocks are perfect for speculators. Whether you’re doing short-term speculating (such as trading) or long-term speculating (hoping your choice eventually becomes a major investment later), you’re gambling. You may not be putting a fortune on the line, but it is your hard-earned money. Here are some small cap guidelines to keep you sane — and hopefully profitable:
Designate risk capital. You allocate your funds for a variety of purposes — emergency funds in the bank, investment funds in your IRA and/or 401(k) plan, and so on. For small cap stocks, allocate a sum of money that you’re comfortable losing in a worst-case scenario; this sum is called risk capital.
This sum has to be high enough for you to diversify your small cap holdings but small enough that losing the money won’t alter your life or general prosperity. Unless you’re more experienced with small cap stocks, consider limiting your exposure to less than 10 percent (or less than 5 percent for novice investors).
Diversify. Yes, if you have 100,000 shares of one small cap stock, you’ll have a fortune if you’re right. But the odds are definitely against you. Losing all or most of your money is too strong of a possibility to ignore. You’re better off having, say, 20,000 shares in each of five different companies.
In the world of small cap stocks, you could have a situation where you end up with four losers and one winner and still come out ahead in total market value.
Buy some, sell some. If you bought 1,000 shares of a stock and it’s up a few hundred percent, take some money off the table and cash out enough to get (at the very least) your original investment back. Then hold the remaining stock for the long term if you’re an investor. If the worst case occurs and the company goes bankrupt, then at least you got back your original grubstake.
Choose a batch of potential winners. When you’re investing in micro caps and/or small caps, get five to ten in your chosen industry or sector. This strategy enhances your chance of a total winning portfolio. When you choose a hot industry or sector, then your chance of getting one or more winning stocks is greatly enhanced. Keep in mind that in lieu of choosing a batch of winning stocks, an ETF (see Chapter 5) or motif investing (covered later in this chapter) may suffice for those who can’t or won’t do the necessary research.
Reading up on what history’s great investors have done is always a good idea, and one of my favorites is John Templeton. He started his legendary multimillion-dollar fortunes (which later turned into billions) investing in micro cap stocks during the Great Depression. Templeton made sure that the companies he invested in had true value (profitability, valuable assets, and so on), where the stock price was significantly below the company’s value. To find out more about John Templeton and his successful stocking investing career, head over to www.sirjohntempleton.org
.
Consider starting your search for good small cap stocks by checking out top organizations that already have those stocks in their portfolios. If experts chose small cap stocks for an ETF portfolio or for a mutual fund that specializes in small cap stocks, those stocks probably offer a good starting point for your research. These experts did the heavy lifting of choosing small caps for their portfolios, so you can learn from them and use this approach as a shortcut in finding quality small cap stocks.
www.nasdaq.com
): This is a premier site for stocks, but it’s also the hub of activity for small cap stocks. You can find stock reports and SEC filings for virtually any small cap (or larger) company.www.otcmarkets.com
): Find small cap stock listings and prices as well as the most active small cap stocks.www.stockwatch.com
): This very active site is packed with news and views of stocks in general but emphasizes small cap stocks.www.smallcapnetwork.com
): This extensive site has research and reports on small cap stocks.www.smallcapdirectory.com
): This site is a search engine for doing research on small cap stocks.Also, consider alternatives to directly owning small cap stocks. Buying ETFs that have a diversified portfolio of small cap stocks can be a safer and more convenient way of adding small cap stocks to your portfolio. To find great ETFs on small cap stocks, do a search at www.etfdb.com
.
Initial public offerings (IPOs) are the birthplaces of publicly held stocks, or the proverbial ground floor. The IPO is the first offering to the public of a company’s stock. The IPO is also referred to as “going public.” Because a company going public is frequently an unproven enterprise, investing in an IPO can be risky. Here are the two types of IPOs:
Which of the two IPOs do you think is less risky? That’s right — the private company going public. Why? Because it’s already a proven business, which is a safer bet than a brand-new start-up. Some great examples of successful IPOs in recent years are United Parcel Service and Google (they were established companies before they went public). A great example of a failed IPO that lost mega-billions was 2019’s WeWork (which … uh … didn’t work.)
Great stocks started as small companies going public. You may be able to recount the stories of Federal Express, Dell, United Parcel Service, Home Depot, and hundreds of other great successes. But do you remember an IPO by the company Lipschitz & Farquar? No? I didn’t think so. It’s among the majority of IPOs that don’t succeed.
For many investors, choosing a small cap stock or considering an IPO may be a daunting task. Fortunately, there are innovative ways to invest in stocks today that weren’t around when I first started investing.
There are ETFs as well as mutual funds in small cap stocks. There are also investment vehicles called “motifs” that specialize in small cap stocks and in IPOs. A motif is a relatively new way to invest and offers an interesting twist on mutual funds and ETFs.
When you look at the interesting variety of motifs, it will make you go “ooh!” Here’s a sample of available motifs (as of this writing):
It seems like you’re limited only by your imagination and the types of securities available. These are the securities that can be in a motif:
A motif is more than a theme-based approach to investing; it’s also a broker. You open an account with the company (at www.motif.com/
) just as you would with any traditional broker. Here are the main features:
All these varied motifs do fall into definable categories, so start your search there:
Motifs sound pretty good, but what are the risks? A motif, much like an ETF or a traditional mutual fund, is only as good as the securities in the portfolio. All the risks of buying and holding stocks, ETFs, and ADRs are present in the motif, just as they would be in any other investment.
For more details on motif investing, check out www.motif.com/
.
18.222.69.152