By Paul L. Silver
One of the primary challenges for all publicly traded companies is accessing capital at attractive prices. The way to access well-priced capital is by attracting the interest of a large pool of investors, both individual and institutional. In aggregate, companies of all sizes spend hundreds of millions of dollars every year promoting themselves through various channels.
However, this challenge is particularly difficult for small and micro cap companies due to limited financial resources and limited sell-side analyst coverage.
LARGE CAPS GET ALL THE COVERAGE
Large cap veteran stocks like Microsoft and GE often are often “covered” by upwards of 15 different investment banks and brokerage houses, each with its own investment opinion and published earnings estimates. Following every quarterly earnings announcement/conference call, analysts frenetically publish equity notes updating their respective audience and the world with company news, updated investment opinion and new earnings and revenue expectations. Although many of these sell-side research updates are generally boilerplate pieces that lack much critical insight, they do serve to keep these companies in the public eye at least four times a year. This phenomenon is unheard of in the micro and small cap world.
More than 90% of the thousands of publicly traded companies that have no analyst coverage are small and micro cap stocks. In fact, since 2000, the number of companies covered by sell-side analysts has decreased significantly. Simply put, bulge-bracket investment banks and brokerage houses invest most of their time and resources in larger companies because that’s where the money is. With larger publicly traded companies, there are more opportunities for a brokerage firm to make a market in the security. For the investment bank side of the business, the capital market transaction related fees are equally compelling reasons to have research coverage of companies with larger market capitalizations.
PROHIBITIVE REGULATORY BARRIERS
There are also significant regulatory barriers as a result of the penny stock rule that effectively prohibit brokerage companies from dealing with smaller micro cap stocks. It is helpful to understand that the I-banks’ and brokerage firm’s incentive for providing sell-side equity research is largely fee driven, and not intended to help the “mom and pop” investor benefit from its expert insight. Although securities regulations have certainly becoming more stringent with respect to separating the financial interests between the bankers and the analysts, there are still plenty of holes in the proverbial Chinese wall.
FLYING BELOW THE RADAR
Due to this lack of institutional sell-side research coverage, many small and micro cap companies fly below the radar, which leads to poor market liquidity and pricing inefficiencies. These pricing inefficiencies are opportunities for smart, aggressive investors to beat the market. Large cap stocks can’t beat the market because they are the market.
DON’T MISS THE NEXT MICROSOFT
Over the last decade, the stocks that have posted the greatest annualized returns tend to share three characteristics; they are obscure, they are ignored, and they are small. The next “Microsoft” is not likely to be currently trading on the NYSE. It may be quietly trading on the OTC Bulletin Board Exchange like a diamond in the rough waiting to be discovered by the world.
Paul Silver joined Wall Street Resources in 2006 as the Director of Research. He has been in the financial services industry since 1995 and began his professional career in auditing with a Big Four accounting firm in New York City. Mr. Silver made the move to Wall Street as a sell-side research analyst for two global investment banks in New York City including Salomon Smith Barney and UBS Paine Webber. At Salomon Smith Barney he was a member of the firm’s research team covering REITs that was consistently ranked #1 by Institution Investor magazine.
