An Expert Look At Microcaps
The Porter & Co. Spotlight is a day late… because we wanted to bring something special to this week’s issue.
… so keep reading…
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Most of the analysts in the Porter & Co. Spotlight are folks Porter has known for years… if not decades.
And they’re the best in the world at what they do. That’s why we’re excited to bring you, usually on Tuesday, exclusive access to their ideas and insight, and research that is normally available only to their paying subscribers.
In this issue, we’re shining the light on a sector of the market that we don’t talk much about here at Porter & Co.
I think it’s well worth your while.
To see past issues of Spotlight… you can read them here.
Sometimes, good things come in small packages… think a diamond ring… a rare gold coin… or a small-cap stock poised to soar…
Here at Porter & Co., we generally focus on well-established, capital efficient companies that have been around for a while. They grow steadily over time and deliver generational, compounding returns to shareholders. Most of the time, these companies are big.
But there are plenty of small companies – with market capitalizations that are a rounding error compared to the more popular mega-caps – that fly under the radar. These can also be fantastic investment opportunities. But they’re often more speculative… and the share prices are volatile.
That doesn’t mean that there isn’t a place for them in your portfolio, though. In fact… just the opposite. The potential gains in micro-cap stocks are extraordinary… if you can find the right ones.
And there’s one guy who I trust to uncover fantastic opportunities in the micro-cap world… his name is Alex Green.
Alex was a close colleague of Steve Sjuggerud, one of my oldest and dearest friends. Like Steve, Alex was a money manager – before realizing he could better serve investors outside of the traditional investment model.
And that’s what he’s done, to big effect. Alex has been the head investment strategist of The Oxford Club for nearly 30 years, and helped guide thousands of investors to better manage their money.
Here… Alex talks about his approach to investing in microcap stocks. And he has an incredible guarantee that I’ve never seen before… you can learn more here.
The Complete Guide To 10X Microcap Profits
Alexander Green, Chief Investment Strategist
When many new investors think of microcap stocks, they assume the term refers to penny stocks. But this is not true.
Penny stocks are a lot like lottery tickets.
Penny stocks’ underlying companies are usually those with poor sales, inferior products and bad leadership. And they’re typically unprofitable, illiquid and easily manipulated.
The penny stock landscape is littered with failed companies that had great stories but no fundamental business behind them.
As a result, they are usually good for one thing and one thing only… losing money.
Microcap stocks, on the other hand, are a very different story.
Microcaps are great little under-the-radar businesses that are destined to become midcaps… then large caps… or be bought out along the way.
In short, microcaps are well-run small businesses with fast-growing sales. I want to see companies with market caps smaller than $3 billion.
I used to only recommend stocks below $2 billion but that limited opportunities for Oxford Microcap Trader members. With a limit of $3 billion you will be getting more recommendations with just as much growth potential as before. But I digress…
The only thing microcaps and penny stocks have in common is that they are both very cheap in terms of share price. But where they differ is that microcaps actually give you a very good chance at BIG wins.
Of course, this flies in the face of Wall Street’s biggest lie, which is that you have to assume more risk in order to make more money.
This is simply not true.
It is possible to make higher returns with less risk. But you have to know how to find the good companies among the plethora of bad ones.
Choosing the Right Microcap Stocks
Microcaps have the benefits of young, cheap companies and the business fundamentals to become large companies in the future.
But in order to achieve this, these companies must meet a few criteria. Now, I look at a few dozen different things when I make a microcap recommendation.
A company doesn’t have to match every single one of those criteria to be recommended, but it does have to match number four, specifically. So let’s take a deeper look at those four criteria…
First, a successful microcap must have a solid, innovative product or service that will allow the company to break through into its own industry and accumulate market share.
Every major company, from Apple (Nasdaq: AAPL) to Netflix (Nasdaq: NFLX), started off small but had an innovative product or service that changed the game within its industry driving its core business.
This product or service must create huge sales growth for the core business. This shows not only that the company’s innovations are in great demand from consumers, but also that the company is successful at marketing said innovations.
Therefore, for my first criteria, we’re looking for microcap companies with at least three consecutive fiscal quarters of sales growth.
If a company can’t sell its fantastic products or services, then it doesn’t matter how innovative those products or services are… It’s effectively pointless. There must be a history of solid sales growth and the prospects for even greater growth in the future.
This alone distinguishes microcaps from the majority of so-called penny stocks, and it gives them the potential to be great investments rather than gambles. Because, as I said, most penny stocks hardly make money… if they do at all.
The products and services they offer are usually gimmicky, and even if they gain some popularity, they likely will amount to little more than a fad. The company will fail as soon as the novelty wears off… And that’s in a best-case scenario.
Here’s the second criteria I look for: increased earnings per share (EPS) over the past year.
No metric in the entire history of the stock market has had more impact than rising EPS. Simply put, earnings per share is used to determine the profitability of a company. EPS is calculated by subtracting preferred dividends from net income and dividing by the end-of-period common shares outstanding.
EPS = (Net Income – Preferred Dividends)/End-of Period Common Shares Outstanding.
In other words, EPS is a financial measure which shows a company’s net income per outstanding share.
Every microcap I recommend needs to have increased its EPS within the past year. A rising EPS indicates a company is improving its financial health and has more profits to distribute to shareholders.
At the end of the day, profits are what make a business successful. It’s also nice and simple as criteria go. Bigger profits are always a good sign. And EPS is the best way to gauge profits for investors.
However, along with rising earnings per share, I also take a look at a company’s book value. Book value represents the company’s total assets minus its liabilities.
If a company’s market value is less than the total value of its net assets, that tells me the company is grossly undervalued.
Value stocks are generally considered lower-risk investments and, when coupled with strong and consistent sales growth, can really supercharge our microcap gains.
In fact, a study published by MarketWatch compared the performance of “safe” blue chip large cap stocks over 88 years with that of small cap value stocks.
The large caps did pretty well. They produced $3.45 million in profit. But the tiny, small cap value stocks produced $69.1 million!
That’s 20 times more money.
So, yes, microcaps can come with high risk if you buy them when they are expensive.
But if you buy them when they trade at incredibly cheap valuations, the upside far outweighs the downside risk.
One reason for this is Wall Street tends to ignore microcap stocks in favor of far bigger companies, which means it ends up covering these companies after most of their biggest gains have already happened.
Just think about it. If a company’s sales are going through the roof but too few people are covering the stock to even notice, then the share price will remain ultra-cheap.
And this gives us an incredible advantage.
We can get in at the lowest possible prices, investing (and risking) far less than we would have to with a large cap.
And then when Wall Street finally notices that sales are doubling and tripling… It jumps in and the stock rockets to the moon. This is where we have a HUGE advantage over Wall Street.
The third criteria is a bit more complex. I am looking for stocks with an RSI>40 over the last fourteen days. Most traditional investors don’t use the RSI or Relative Strength Index. But it is important when it comes to momentum.
RSI is a measure of buying and selling pressure being put on the stock by the broader market. I don’t want to get too into the weeds here, but for our purposes, an RSI over 40 is ideal. At 40 and up, it tells us that buying pressure is driving a stock higher and gaining momentum.
It helps me determine exactly when a microcap is set to move big.
See, even if a business is performing well, it takes buying pressure to start moving its value forward. It gets unstuck from the mud and moves in the right direction.
However, this is more of a timing metric for our play than a measure of the stock’s overall health and how high it could potentially go. To find that out, there’s one last criterion I always look for in a stock…
I need to see big, recent, insider buying.
Insider buying is one of my favorite metrics for analyzing any stock, not just microcaps.
Money talks, as the old saying goes. That’s why when company insiders are throwing vast amounts of their own money into their company’s stock, it screams “Buy!”
Those insiders know things about their company that Main Street investors aren’t privy to… like sales since the last quarterly report, new product releases or an upcoming FDA approval. If an insider likes where their company is headed, they’ll buy shares. And they have to tell you when they do – it’s the law.
If the people who know the company best are buying up shares left and right, it’s a sign that you should likely follow suit.
A company insider might sell a stock for many reasons. Maybe they’re buying a house or car? Maybe they need to pay a divorce settlement? Maybe they’re paying their kid’s tuition? It doesn’t necessarily mean the company is doing poorly.
But insiders only buy shares of their company for one reason, they think they’re about to go up in value. So, when an insider or group of insiders start loading up on shares it’s perhaps the best sign for you and I that big things are coming for that company.
If a microcap meets all four of these criteria, the other things I look for usually fall into place.
But importantly… How do we capitalize on microcaps while limiting our losses?
How To Take Profits (And Avoid Losses)
Whenever we make an investment, we should know in advance what our potential risks are and strategize to minimize them.
For that reason, I recommend using a stop-loss policy to protect both your invested principal and your profits.
A stop is a set price at which an automatic sell order is initiated. As a general rule, I often recommend using a stop policy on any stock positions in our portfolio.
Whenever a stock in our portfolio hits its stop price, we will automatically sell the stock at market. This helps to prevent small losses from becoming bigger, unacceptable losses.
It’s true that many great companies will bounce back eventually. But “eventually” can be a long time. Our policy is not to argue with the market.
We buy based primarily on the near-term business prospects for our recommended companies. But we understand, too, that changes in fundamentals are immediately reflected in share prices. So that’s where we base our sell decisions.
In this service, I will use laddered stops. In other words, as a recommendation moves higher, I will raise our stop accordingly to protect our principal and profits.
Lastly, there’s the question of taking profits as the stock moves up.
In general, I believe in holding on to your winners… so long as they keep winning.
You don’t want to prematurely cut short an uptrend by selling before you can collect maximum potential profits.
However, a good rule of thumb is to sell half of any position that gains in value by at least 100%. This will allow you to take back your entire principal and let the remaining position ride.
For example, let’s say that you’ve purchased shares of a stock for $50 and a few short weeks later the stock is valued at $100. You can then sell $50 worth of stock – reclaiming your principal and let the remaining $50 appreciate in the market.
You’ll be playing with the house’s money, so to speak, and thus incurring no risk to your original investment, which you can then reinvest into other stocks.
The Path To 10X Microcap Profits Starts Here
If you follow my system for microcaps, you can identify these situations well in advance and get the chance to make very big money.
When you can buy stock in companies with sales rocketing higher at ultra-cheap valuations, there is no better recipe for success.
I believe microcap stocks offer the best opportunity to accumulate incredible wealth. With my strategy at your disposal, you could see gains of 1,000% (or higher) thanks to this underappreciated part of the market.
But as with all investing, there are some risks. So be sure to apply my risk management strategy by using stops and collecting profits in an intelligent manner to maximize your long-term gains and minimize your losses as much as possible.
Alex has put together a presentation about how micro-cap stocks can be a great addition to your portfolio. Again, this is a bit outside what we usually recommend here at Porter & Co. But it’s well worth your time to see what Alex has to say.
You can review Alex’s presentation here.
Good investing,
Porter Stansberry
Stevenson, MD