Information Flow in the Micro Cap World

Over the past 20 years, the amount of information available on financial markets has exploded due to the emergence and proliferation of the internet and social media.  Instant reporting of news followed by instant analysis has become the norm.  However, there are few quality control measures on the web as the medium is open to all.  Although this democratization and decentralization of information flow has many beneficial aspects, it has also led to some unintended consequences.  Paradoxically, perhaps, the disintermediation of the traditional purveyors of information, analysis, and opinions (the Wall Street banks) has not led to increased efficiencies in the marketplace; rather it has led to increased volatility of individual names and, therefore, a heightened opportunity to take advantage of fundamental inefficiencies in the pricing of stocks.

The emergence of computer-driven algorithms and other shorter term trading strategies has also increased the short term volatility of many stocks as they traded based on news flow.   This opportunity is particularly robust in the small and micro-cap investment space due to lower absolute liquidity, less sophisticated company management teams, even less Wall Street coverage, and companies whose business models and prospects may not be well known.

Exacerbating the issues caused by this incredibly robust information flow, are the changes in Wall Street coverage of small and micro-cap stocks and the increased ease and lowered cost of investing across all market participants.  In particular, as Wall Street has increasingly abandoned coverage of the smallest cap and least liquid public companies, the ability of company managements to get their story heard and business prospects understood has been diminished.  These companies are invited to fewer conferences, are covered by fewer analysts, and are difficult to buy for many institutional players.  Early identification of these companies, before they are large enough and liquid enough to be recognized by Wall Street can provide an opportunity to invest before their growth prospects are fully discounted in the price of the stocks.  As they get discovered and institutional ownership expands, returns can be enhanced by multiple expansion as well as the inherent growth of earnings and revenues.  Active management can add particular value in this space by properly identifying and valuing attractive growth opportunities and then using the inherent volatility of the marketplace to establish and manage investment positions.

As we approach another earnings reporting season in a few weeks, we are reminded of these structural inefficiencies and the need to have a robust, comprehensive, objective, repeatable process to filter out the noise and mis-information.  The use of a quantitative screen at the front end of our investment process allows us to focus our investment analysis on those companies with significant, measurable, and real improvements in their growth rates in order to identify companies and industries exhibiting superior growth prospects.  We can find attractive growth opportunities independent of either Wall Street coverage or conference participation which enhances our ability to find companies early in their growth trajectories.   Our screen also can focus our research attention on new emerging growth areas that have not yet been widely discovered in the mainstream media.  We are excited to see what new companies and investment themes get uncovered in the upcoming earnings season.