Microcaps, compared to publicly traded large-cap corporations, have a notable disparity that makes them more challenging for prospective investors. Microcaps typically generate limited – if any – revenue, making in-depth financial analysis more difficult. It’s hard to do due diligence on a stock when there isn’t much financial information available about the company.
Many microcap companies strive to project future earnings, but the truth is that they often lack the ability to do so accurately. Small companies – whether public or private – frequently do not have substantial revenue or a viable product that customers can buy. This makes microcaps similar to start-ups, despite being publicly traded. As a result, microcaps need to rely on qualitative updates to inform their shareholders. They must tell an ongoing story, which is always evolving.
To succeed, microcap executives must be open and consistent in sharing information with stockholders, discussing positive and negative developments and, yes, even admitting to mistakes — which tend to happen often in early-stage companies.
Above all, microcap management teams should cover certain essential topics in their annual regulatory reports and investor presentations.
The problem is, due diligence takes time. And with microcaps, the companies may not have enough of an operating history – or even revenue – to adequately evaluate the financials. Lacking that, wouldn’t it be helpful to have a scorecard of the fundamental business questions that need answers before we buy a penny stock?
Here it is.
After wading through scores of regulatory filings, pitch decks and investor presentations, DealFlow has found four critical points that are common to all convincing investor presentations. When addressed in detail in regulatory reports as well, the answers to these four questions can put to rest a lot of investor uncertainty over whether to buy a stock:
- Who are the key management people and what are their backgrounds?
- What is the status of the product or service? (When will it be ready? What obstacles stand in the way?)
- What are the revenue projections? (Does the company convincingly demonstrate understanding of its customers?)
- How long is the runway? (Current cash balance and burn-rate? Scalability?)
These questions are almost always covered in the investor presentations of major corporations on the verge of launching an IPO, typically detailed under the section “use of funds.”
Before putting their money into a stock position, sophisticated investors look for information regarding a company’s hiring plans, product roadmap, go-to-market strategy, and the path toward a convincing business model.
However, many microcap companies do not bother to cover these points and even when they do, many are not consistent in their communications.
Investors should be wary of microcaps that fail to address these points– not because it suggests anything sinister is afoot, but because a management team that overlooks these crucial issues in marketing their company to investors may well be overlooking critical issues that are core to the success of the business, as well.
Microcap shareholders should receive updates on the company’s management. Who are they? What are their backgrounds? Is the team growing or contracting and if so, why? Is everyone on board with the company’s goals?
These are important questions because executives typically play an outsized role at smaller companies.
Whatever is for sale, microcaps should see the need to keep their shareholders up-to-date on the product roadmap. When will it be ready to market? How has the offering evolved since the last update? Have there been any noteworthy advancements or milestones? Any problems, such as supply chain issues? Corporate honesty and transparency are two cornerstones of investor confidence, even if the news may not be as bright as the company would prefer.
What does the sales pipeline look like? This is a very simple question because a product is either gaining traction in the market or it isn’t. Can the company describe its target customers and the problem the product solves? What’s the customer response been like so far? Can the business model scale effectively? Is there a chance that the company will need to pivot due to clouds on the horizon? If so, what is the timeline and how will it affect the sales pipeline?
Do they have enough runway?
Sharing updates on cash balance and burn rate are vital if microcaps want to keep their shareholders informed. As a publicly traded company, it is fairly easy even for retail investors to determine when a microcap is running low on cash. Companies that stay ahead of this issue in their communications to investors are better able to explain the growth plan. It’s also evidence that the company is prepared and management understands what’s going on. The questions investors will want answered include: Will the current runway enable the business to start generating revenue? Will it position the company for scalability? How soon can the company achieve positive cash flow?
As with start-ups, microcap companies often need to raise (and spend) capital until the pieces fall into place. But investors need to be aware of this business fact of life and kept current on the state of the balance sheet. This helps set and maintain realistic expectations among stockholders, resulting in greater share stability.
Finally, potential investors should take note of the microcap’s investor relations firm, if it employs one.
After reviewing enough corporate presentations, investors are likely to begin noticing similarities in the organization of information and the way companies share their narratives. There is a strong chance that these companies are using the same investor relations firm. Some take a cookie-cutter approach to preparing investor presentations, which may be useful in holding down their costs, but may not serve potential stockholders trying to evaluate whether a certain microcap company might make a profitable investment.
These components of a useful investor presentation are obviously not a predictor of actual stock performance. But on the analytical level, when accurately presented in good faith, these four points can go a long way toward instilling the confidence an investor needs to buy a stock in the first place.
And that’s a start.