Digging for Hidden Gems Among Small Caps
Since my passion is to look for the best bargains I can find, I’d like to talk about where I think the bargains are right now: emerging market small-cap companies.
For our investing purposes, we define emerging market small-cap companies as those having a market capitalization at the time of purchase of less than US$2 billion. I believe many small-cap companies have the potential to grow into large-cap companies. Thus, the prospect for gains can be very exciting.
Small-cap companies in emerging markets are generally under-researched and not as established as their large-cap counterparts. Some have very short track records, not much background and little publicly accessible information, therefore presenting a higher level of perceived risk and deterring many investors. But for these very reasons, share prices of small–cap companies are less likely to reflect their true value with fewer analysts covering them, thus creating attractive investment opportunities. We try to work these “shortcomings” in our favor, essentially trying to capitalize on the challenges. Proper research and due diligence goes a long way to unearth deep and highly valuable treasures in the hidden chest of small-cap investing.
Small-cap companies require commitment, including travel, to see what is happening on the ground. I was recently in China researching a tea company, visiting tea plantations in the rugged mountains of the Fujian Province. It was very cold but the trip was very fruitful as we got to observe and understand how the tea was grown, harvested and processed. Trips like these take time and effort but they are fundamental to understanding the workings of small-cap companies.
When we look at small-cap companies, we evaluate the management of the company. We look at their competence and effectiveness. Do they understand their business well and are they focused on good returns with long term objectives? We have often found that small cap companies have stronger and steeper growth as they are mostly growth-oriented, highly focused, and risk-driven. Management has an entrepreneurial mindset and they thrive on taking up new initiatives and challenges.
Many investors are looking at emerging market small-cap opportunities as the market picks up after the global financial crisis. In such circumstances, small-cap companies may be able to outperform the overall market, as they tend to bounce back quicker than large caps when the economy picks up.
If you are considering investing in emerging market small caps, I think three things are most important: (1) study the companies and their respective industries very intensively, (2) have patience and (3) take a long-term view in order to see the long-term gain. These are a few resolutions that might be worth adding to your list this year.