CLASSES TO GO!

Small Cap Pros and Cons Arlene Skaggs

BIVA Board Director

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Disclaimer• The information in this presentation is for educational purposes only and is not

intended to be a recommendation to purchase or sell any of the stocks, mutual funds, or other securities that may be referenced. The securities of companies referenced or featured in the seminar materials are for illustrative purposes only and are not to be considered endorsed or recommended for purchase or sale by BetterInvesting™ National Association of Investors Corporation (“BI”) or the BetterInvesting Volunteer Advisory Board, its volunteer advisory board (“BIVA”). The views expressed are those of the instructors, commentators, guests and participants, as the case may be, and do not necessarily represent those of BetterInvesting™ or BIVA. Investors should conduct their own review and analysis of any company of interest before making an investment decision.

• Securities discussed may be held by the instructors in their own personal portfolios or in those of their clients. BI presenters and volunteers are held to a strict code of conduct that precludes benefiting financially from educational presentations or public activities via any BetterInvesting programs, events and/or educational sessions in which they participate. Any violation is strictly prohibited and should be reported to the President of BetterInvesting or the Manager of Volunteer Relations.

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• Microsoft, Wal Mart, Home Depot and others started as “small” companies and went on to “greater” things

Moral: Can we afford not to look at small companies for our portfolios

Proverb: From small beginnings come great things

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At a Glance: Advantages of Small Companies

• May achieve faster growth than larger companies

• Less complicated structure

• May have a Niche Market

• Can provide portfolio with undiscovered companies at a good price

• Increased choices for investment purposesLets explore these features individually…….

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Faster Growth• Easier to increase sales of $10,000 to $12,000

(20% growth) versus a large company trying to increase sales from $10 billion to $12 billion– “Market/Investors/Analysts” pay attention to the

percent of change in growth rates

• Can adapt to changing conditions more rapidly than larger companies

• Able to seize opportunities quicker than large companies– Enter new markets– Launch new products, etc.

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Less Complicated

• Less Bureaucratic

• Business Model (or how they make their money) easier to understand

• Tend not to be diversified

• May have lower debt levels, since borrowing may be more difficult for them

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Niche Market

• Niche market – a market which has accessible customers, a need which is not being met and no competitors for the product

• May have a single or “specialized” product– May be a copyright or patent– Ideal for a small company

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• A small, quality company with low stock price may be due to funds unable to invest in them and/or analysts do not follow them.– Many Mutual Funds are unable to buy

blocks of stock that do not meet their defined prospectus

– Generally, analysts do not follow stocks which institutions/funds will not buy.

Provide Portfolio With An Undiscovered Company at a Good Price

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Increased Choice for Investment Purposes

Many more small companies than large companies

Large-Cap 835

Mid-Cap 1350

Small-Cap 2800

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At a Glance:Disadvantages of Small Companies

• Market volatility with greater risk

• Unfamiliar names and less information

• Vulnerable to bad news/competition

• Growing too fast

• Lack of management experienceLets explore these features individually…..

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Market Volatility with Greater Risk

• Stock price affected by popularity which can make stock overvalued

• Less liquid than medium or large companies:– Limited number of buyers and sellers– Low volume of shares can make price

fluctuate more than 5% in one day – Bad news may make buyers scarce, causing

a sudden drop in price.

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Unfamiliar Names and Less Information

• Company names may be unfamiliar • Companies may not have enough history to

meet our criteria (5 years)• Not a lot of exposure in the press

– May only have local coverage

• Analysts’ coverage will be low or not exist

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Vulnerable to News Or Competition

• Vulnerable to internal bad news – Dependency on one or two products

and/or declining sales– Loss of sole or largest customer

• Vulnerable to competition– Loss of niche position as others enter

the market– Difficulty competing with a large

company that enters the field/market.

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Growing Too Fast

• Management or the original founders may have been able to manage a small-scale operation but not an expanding operation

• May not have resources to meet increased demand

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Lack of Management Experience

• Management may have no experience in developing continuity in management

• May be dependent on original managers rather than brining in experienced outside managers

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Finding Small Companies

• All small companies are not small-cap stocks• “Capitalization” can be determined by:

1. Market Capitalization• Shares Outstanding x Share Price

2. Capitalization by Sales (Revenues)*• Amount of yearly sales (revenues)

*BetterInvesting recommends considering size of company by its annual sales. Sales are a fundamental for analysis and not dependent on price or popularity of the stock.

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Designation of Capitalization/SizeBetterInvesting

Designations By Sales

Small: Under $500M

Mid: $500M to $5B

Large: $5B +

• Market Caps based on shares outstanding x share price*

• Small-cap: $300M - $2B

• Mid-cap: $2B to $10B

• Large-cap: $10B +

* Generally used by Analysts

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“Capitalization” Can Be Deceptive• A small-cap company could be a small

company (measured by revenue) and a mid-cap (measured by market capitalization)– Example: Company X has:

• sales of $387 million (small)• capitalization of 3.2 billion (mid-cap)

• Market Capitalizations are greatly affected by popularity and price. – Increasing price = increasing market-cap– Decreasing price = decreasing market-cap

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What Should We Look For: Try to find a company when it is in its explosive

growth period.

Break Even Pointrt

BestInvestmentOpportunity

Speculation

Life Cycle ofA Successful

Company

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What Else Should We Look For?

• Strong balance sheet

• No debt

• Growth – above 15%

• Good Management

• Niche with little competition

• Availability of information

• Understandable product

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How can we minimize our risk?

Follow BetterInvesting’s guidelines:• Company should have:

–Minimum 5 years of financial data

–Consistent growth and potential future growth

–Good management

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How Can We Minimize Risk:

AVOID:– Turnarounds– Too rapid, unsustainable growth – Insider ownership less than 15%– Companies “just about to discover…” (not

there yet)– Companies trying for a bigger market

saturated by large companies– Over-priced small companies

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Finally When Considering Small Companies

Remember:• Many will survive• Many will not

– Many can also adapt more easily than larger companies

• Do your homework and research!

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