Scoring BIG in SMALL Caps (Pt. 1)

Educational, Small Caps Jun 4, 2020 / Reading Time: 2 mins
By Divik Nigam Reading Time: 2 mins

A question always in an investor’s mind, where is the money?
Amidst the ramifications of the COVID-19 pandemic, which has degraded Australia’s economy, lies companies which are growing dramatically. The differentiating factor you may ask – are the qualities of the business which provide a competitive advantage and catalyse its expansion during all times. Believe it or not, such companies exist outside the perfect world and even in the Small Caps universe!

When it comes to investing into Small Caps, investors should be willing to trade increased risks for abnormal gains. The investing approach adopted should therefore be much more focused on the fundamental aspects of the company with a long-term growth perspective. With this mentality, investors should be accepting of short-term losses for enormous upside potential. This potential is the separating factor of all companies in the Small Caps world, and is correlated with the company’s ability to expand, with strong roots to endure any future downfalls. Furthermore, the growth potential of companies in the Small Caps universe, is more deeply characterised by an array of multifaceted top down and bottom up qualities, consisting of but not limited to, global revenue streams, macroeconomic themes, government funding, strong management qualities, partnerships and a product which has a competitive advantage and is able to last during periods of limited supply/demand.

In conjunction with the above factors being considered, investors should also take on a much more critical analysis approach to tailor the relevance of each aspect to the specific company being studied. By adopting this mentality, investors will be able to see between the lines and discover that the above facets, whilst seeming to all allude to company growth, may not entirely be needed.

For example, a company which has national market dominance over its competitors might not try to establish global partnerships and trades unless it is confident enough to be able to secure a sufficient international market share. If the company pursued international expansion, not only will it have a competitive disadvantage overseas (due to a proportionally lower market share), but it also risks losing the current leverage it has nationally. Hence, global revenue streams may not be a catalyst for such companies.

Thereby, by combining a critical analysis of the above aspects with a long-term growth perspective, investors can establish a fundamental framework by which they can eliminate a far majority of Small Cap companies within the universe. This ideology relates to the existence of a ‘competitive advantage’, whereby there is a certain company which, contingent on its competitive advantage, will outperform all other companies in that specific sector/industry.

It may also be the case that while investors scan the Small Caps landscape, they come to realize that certain sectors and industries will require specific tools which can be used to gauge company potential.

Key aspects such as a company’s growth figures, general health and business stage can provide an insight into a more tangible outlook for the firm, which we will be covering in the next part of our “Scoring BIG in SMALL Caps” blog series.