Small Stocks, Big Money

Interviews With Microcap Superstars

Dave Gentry

• Publisher: Wiley
• Year: 2015
• ISBN:
  9781119172574
• Edition: 1
• Topic: Business
• Subtopic: Stocks
• Index: Business

Small companies come with big risk, but potentially life-changing reward

Small Stocks, Big Money provides first-hand perspective and insider information on the fast world of microcap investing. In a series of interviews with the superstars of small stocks, you'll learn how to discover the right companies and develop a solid investment strategy with a potentially big payoff. Each chapter includes a short bio of the investor in question, and provides key insight into the lessons learned from the investments that made them millions—or in some cases, hundreds of millions. You'll learn each investor's top stock picks, and how they originally chose the investments that became their gold mines. Whether you're a professional investor or a novice, this book is a unique and valuable source of information for anyone interested in the volatile world of small stocks and big money.

The smaller the company, the bigger the risk—and the bigger the potential payoff. These interviews show you how to avoid or mitigate those risks, and how to choose the stocks with the best potential from the perspective of those who have done it very, very successfully.

• Learn the nuances of microcap investing
• Read the stories of the pros who have made millions
• Gain expert insight from top microcap investors
• Avoid the potential pitfalls and reap the big rewards

Taking a risk on a small company can lead to tremendous gains when they become an industry giant. The trick is in choosing the company that is likely to follow that trajectory, and allocating your investment appropriately to protect yourself in case of disaster. Small Stocks, Big Money gives you a head start by teaching you what the pros wish they knew then.

PART I

Big Companies Start Small

CHAPTER 1
Microcap Stocks, the Neglected Asset Class

Considering the fact that almost 50% of the approximately 16,000 public companies (this number includes OTC market stocks) in the United States have market caps of under $500 million, the lack of research and media coverage on this sector is surprising.

U.S. Public Companies' Market Caps

• 7,360 under $500 million
• 6,622 under $250 million
• 5,713 under $100 million
• 5,053 under $50 million

—Thomson Reuters, September 7, 2014

The microcap sector is one of the least-understood asset classes on Wall Street. It is also the most neglected sector by the major financial media outlets. CNBC, Fox Business, and Bloomberg offer precious little content or commentary on microcap stocks. Fox Business's Charles Payne is the only mainstream Wall Street media pundit who has experience in the sector. Jim Cramer, on his show Mad Money, does occasionally comment on microcap companies (in fact, he has mentioned several RedChip client companies over the years), but he is largely focused on large and mid-caps. My show, Small Stocks, Big Money, is the only show approved by major networks (Fox Business, Bloomberg Europe, Bloomberg Asia) that focuses exclusively on microcap stocks, and at this point we still have to pay for our air time.

It is not often that we see the major business media outlets discussing, providing commentary, or interviewing the rainmakers in the U.S smaller-cap sector. Rarely do we see interviews with the CEOs of public companies with market caps under $250 million, though there are plenty of fast-growing, profitable companies from which to choose, some of which you will read about in this book.

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What the mainstream financial pundits forget is that big companies generally start small. In my debate with Herb Greenberg, Gary Kaminsky, and David Faber on CNBC in November 2011, related to reverse merger Chinese small-cap stocks, I tried to make the point that Blockbuster Video, Texas Instruments (NASDAQ: TXN), and even the New York Stock Exchange (NYSE: ICE), went public through the reverse merger process, an alternative to IPOs used by many small companies.

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A reverse merger is an inexpensive way of going public that circumvents the IPO process and the associated costs. This alternative listing mechanism is used today by many start-ups and less developed companies.

Greenberg and others also betrayed their lack of knowledge of the microcap sector when they questioned whether institutions purchased small and microcap stocks covered by RedChip analysts when in fact hundreds of institutions meet with the CEOs of RedChip companies every year, many of whom build large positions in our stocks. Not only did they cut me off seven times in a 15-minute discussion, they implicitly disparaged the entire microcap asset class over and over again. Their show, called The Strategy Session, was later canceled.

Over the past 24 months, NASDAQ OMX Group and the NYSE: MKT has listed dozens of “small” companies that went public through the reverse merger process on the OTC markets, which is the home of thousands of smaller companies intent on listing on a major exchange. Another problem with the sector is that there are simply not enough independent analysts covering microcap stocks. There is a plethora of issuer-sponsored research, some of it quite good, but because it is paid for by the issuer, in some circles it is not given the respect that it deserves. The investment banks who focus on smaller-cap companies, with few exceptions, save their research for companies they back.

Considering the fact that almost 50% of the approximately 16,000 public companies (this number includes OTC market stocks) in the United States have market caps of under $500 million, the lack of research and media coverage on this sector is surprising. Michael Corbett, CEO of Perritt Capital Management, summed the issue up well when he explained that it is much easier for analysts and the pundits to talk about the big companies because there is so much history and information. Also, the white-shoe firms such as Goldman Sachs and JP Morgan learned a long time ago that because smaller stocks lack the liquidity of the larger names, it's harder to generate substantial fees trading these stocks. So it's best to stick with the big and midcaps where the fees are bigger and the information is better.

Sometimes big companies with long track records lose market cap due to a lack of execution, innovation, or poor financial management, and fall back into the microcap category. Superstar Phil Sassower invested in New Park Resources (NYSE: NR) in 1986 at 20 cents a share after it was delisted from the NYSE. He revitalized the company with new money and management, refocused the business, and made an enormous profit on his investment.

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You will hear over and over again in this book from the Superstars that management is the most important factor to consider when investing in small, lesser known companies. It does not follow logically that great technology or a great idea translates into a successful company.

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Jim Collins's epic study of great companies in Good to Great teaches us that the first and most important thing a company must do to get better or to become great is to get the right people on the bus and get the wrong people off the bus. If this is true for big companies, then it is extraordinarily true for microcaps.

Collins's study looked at over 1,400 companies and found only 11 that made the transition from good to great, defined by outperforming the market by at least three times over a 15-year period. If less than 1% of those big companies made the transition from good to great, then one can imagine how few microcaps make the transition from bad to better, okay to good, or good to great.

Buying microcaps when they are least efficient, before the truth about the company is fully known by the Street, is how investors can maximize their returns. And this is what the Superstars have been able to do consistently. Inside this book you will find dozens of examples of how the Superstars invested in companies, many times when no one else would, because they had the acumen and the foresight to understand what others missed, a technology, product, or service that with the right capitalization, management, or marketing could become successful.

Barry Honig and Phil Frost invested in MusclePharm (OTCQB: MSLP), when it was a subpenny stock and hemorrhaging losses. They restructured the company, did a reverse split, and led a $10 million capital raise. What they saw was a company with industry-leading muscle-enhancing nutritional products and a very large market opportunity. Eighteen months after their investment, the stock traded at a $175 million market cap. The stock has since fallen to a $64 million market cap. In 2014, the company generated $177 million in revenue, with a loss of $13 million. For the first six months of 2015, it reported revenue of $91 million and losses of $14.5 million (see Figure 1.1).

Figure 1.1 MusclePharm (OTCQB: MSLP)

Data Source: Thomson Reuters Corporation.

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Every stock has a life cycle. Every stock has its proverbial ups and downs. But the life cycles of microcap stocks are different, more erratic, and more volatile. They tend to move up faster but can also fall faster. Some trade in familiar patterns, up two to three points like clockwork only to fall back down two to three points the next day, week, or month. Indeed, the microcap world can be fast and furious. There are momentum plays every day of the trading year with daily and weekly price swings of 10% to 100%+.

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The neglected asset class is full of opportunities for large gains, but is also fraught with risk. The chart of Galectin Therapeutics (NASDAQ: GALT) in Figure 1.2 tells a fascinating story. The stock closed at $8.08 December 31, 2013. Just 10 days later it closed at $15.10, an 87% gain in two weeks. It pulled back to $11.59 on January 24, 2014, then burst to $18.30 on February 27, 2014. Less than three months later it was back at $10.28 but then gained 42 percent over the next seven weeks.

Figure 1.2 Galectin Th...