Five things to remember about small-cap stocks

Five things to remember about small-cap stocks

Small-cap stocks have really taken it on the chin these past few months and the past week has certainly been horrible with big declines across the board.

Based on the questions our company receives from investors, though, it seems people need to be reminded about the dangers and unique features of small caps. Or maybe things have just been too good in small-cap land and investors are now too complacent.

Either way, here are five characteristics of small caps that all investors should remind themselves of every now and again.

Small caps are volatile

Volatility does not by itself make small caps bad, but investors need to separate market swings from fundamentals. Declines of 15, 20 or 30 per cent in a short period do not always indicate that the company’s fundamentals have seriously deteriorated.

Maybe some large holder just needed to sell stock. Maybe there was a fund manager change. Maybe there was a bad rumour on the Internet.

Company prospects don’t change that much on a weekly basis, but stock prices can. You cannot ignore price movements, but don’t read too much into them, either.

Small caps are notoriously bad communicators

Patient Home Monitoring Corp. (PHM/TSXV) recently lost close to $200 million in market cap on something that could have been largely prevented with a simple $500 press release.

Insiders had sold and transferred a massive amount of shares to a specialized health-care fund, but investors only saw insider selling and panicked when there was no word from the company.

Days too late (after a big decline), a conference call with investors did little to clear up the issue.


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Small caps should not be traded on quarterly results

Investors often ask how the numbers are for companies that have yet to record any quarterly revenue. Many companies simply don’t have revenue or earnings as they develop their business plan. This is particularly true in the biotech and resource sectors.

For a small company with a 10-year business plan, a 90-day quarterly window really means very little. Do not sweat quarterly results.

You are going to take some nasty hits

No matter how careful you are, you are going to get some losers when investing in smaller companies.

You may buy into an over-promoted stock, or pay too much for a company that doesn’t have any revenues today and never gets any either.

Hopefully, though, your winners will far outweigh your losers. You really only need one or two multi-baggers to change your portfolio for the better.

For example, shares in Long Run Exploration Ltd. (LRE/TSX) are down 89 per cent in the past year, but they might be offset by shares in CRH Medical Corp. (CRH/TSX), which are up 561 per cent in the same time period.

Small companies are heavily tied to single contracts

Growing companies often rely on a single large contract to get things going. This is not bad in and of itself, as companies need to start somewhere, and a big contract is a good endorsement of a particular product or service offering. But the loss of a big contract will hurt.

Take Neulion Inc. (NLN/TSX). It recently lost an NHL contract that accounted for 20 per cent of the company’s business, but its stock lost 50 per cent of its value as news of the contract loss spread.

Peter Hodson, CFA, is CEO of 5i Research Inc., an independent research network providing conflict-free advice to individual investors (

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Five things to remember about small-cap stocks

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