Top 5 Reasons to Pass on Opportunities
Did you know there are over 2,800 microcaps (<$300 million market cap) in Canada?
They represent over 85% of the public company universe in the country.
That’s A LOT of opportunities. Especially considering that the average microcap investor is a part-time retail investor or, at best, a small shop with a few analysts.
At Rivemont, we are a team of two working on the microcap strategy to tackle this vast universe. Therefore, we must have a way to filter opportunities quickly. My goal is to say no as fast as possible so I can focus on the companies that truly deserve my time and attention.
Here are the main (and quickest) reasons why I pass on something:
1- No Track Record of Profitability
It’s challenging to build a sustainable and profitable business. Most CEOs of unprofitable companies aim to become profitable (‘‘only 1 or 2 quarters away!’’, they say), but few achieve it. Sadly, most unprofitable opportunities will dilute their shareholders forever.
When you find a company that’s been profitable for at least a couple of quarters, you know it can likely stand on its own. That removes a lot of risks.
2- Low or No Revenue Growth (<10%)
The microcap space is inefficient, especially below the $100M market cap threshold (nanocaps). Companies should aim to get out of the nanocap space as quickly as possible to get on the radar of more prominent, sophisticated institutional investors.
However, if you’re a $15M revenue business growing 5% a year, it just won’t cut it. To reach escape velocity, nanocap companies need growth!
I’m typically looking for companies with $10-50M in revenues that can grow 20%+ per year for the foreseeable future.
3- A Weak Balance Sheet
A weak balance sheet can mean negative working capital (except for SaaS companies) or a lot of debt.
When a company needs to raise capital, it often issues shares and dilutes existing shareholders. Dilution to finance operating losses frequently equals poor stock performance.
Having no cash removes optionality.
Constantly needing capital also distracts the management team and forces them to think short-term.
All of these lead to bad outcomes.
4- A Management Team I Can’t Trust
Judging management teams is all about reps. You need to do lots of meetings for your pattern recognition engine to improve. That said, there are some obvious red flags: a history of spending egregious amounts on stock promotion, chasing every new fad (cannabis, crypto, AI, etc.), a poor track record at past companies, a criminal record, etc.
The tricky part is that shady CEOs will likely achieve excellent stock performance in the short term through promotion or deception. It’s tempting to trade these stocks and chase a quick gain.
However, these stories almost always end badly. Don’t fall for it.
5- Exposure to a Commodity
Anything linked to a natural resource is typically a pass for me. Companies selling commodities don’t have any pricing power, so they have to make do with the prevailing market price. Since I don’t have a view on macro cycles, making medium to long-term forecasts is next to impossible. Even companies that service those industries tend to be pretty cyclical, too.
Outside of natural resources, I also avoid commoditized products or services with low barriers to entry and little differentiation in the marketplace.
Do I Miss Multi-baggers?
Sure.
But… by sticking to these criteria, I probably avoid 90%+ of what gets other investors in trouble. And not getting in trouble is pretty darn important in microcaps.
I don’t mind seeing others make money on things I passed on as long as my reasons for passing were appropriate.
Taking calculated risks ensures I can stay in the game for the long term!
Disclaimer
This publication is for informational purposes only. Nothing produced under the Stocks & Stones brand should be construed as investment advice or recommendations. Mathieu Martin, the author, is employed as a Portfolio Manager with Rivemont Investments. This publication only represents Mathieu Martin’s own opinions and not those of Rivemont. Always do your own research and consult a professional before making investment decisions.
If you’d like to invest in small public companies, check out this post.
Great points. It's so easy to look back and see what you didn't own that went up. But it's also important to look at what you didn't own that tanked.
I think the point #4 is something that I struggle to remember. This lesson is something that has a shelf life of 18-24 months for me.
Another point similar to #2 is that the business needs to get big enough to escape the nanocap trap. It will never get a huge multiple with EBIT of 500k-1million. It needs to get big enough to be more durable and to (eventually) catch a bid. Just my opinion of course.