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There is absolutely nothing wrong with gambling at the casino. As long as you know you are at the casino. 

I am talking about investing in small-cap companies. Where the failure rate is +90%. And it turns out the odds don’t get better because a company decides to go public.

Despite the certainty of losses, the allure of the 10x return is addicting. Like winning big in Vegas. We keep coming back for more. 

And to be fair, this part of ‘capital formation’ although full of ‘hype’ isn’t wrong. It’s often early, wildly inefficient, highly manufactured and, yes, full of scumbags and dreamers alike. But, at the end of the day, 1 out of 100 is an important discovery/idea that wouldn’t have come from a large company or management consulting report (says one of my near genius entrepreneur friends).

Trying to find the next Tesla or Shopify is intellectually challenging, can be financially rewarding and it’s also fun. Because:

“There’s always a bull market somewhere”

But, how can we tell a real company from a stock promote?

Battle Scars.

I have been blessed with the opportunity of failure. Failing fast & failing often. There is no better way to learn investing.

Over my 15 year career as an analyst, portfolio manager & advisor I have listened to thousands of pitches, invested in hundreds of companies and worked closely with dozens of CEOs. 

This journey has earned me countless battle scars. A few thankfully have healed into WISDOM I would like to share with you.

The most important thing is understanding INTENT. Nothing wrong with building a company that fails. As long as you actually tried to build it. The opposite is called a ‘promote.’ That is a company in the business of promoting their stock, nothing more. Buyer beware!

To figure out if a CEO’s intents are honourable, I constantly compare what they say to what they do. I’ve also created a TOP TEN LIST of Red Flags to help spot an ‘emperor with no clothes.’

Red Flags.

By no means is this list exhaustive or conclusive. A couple red flags does not make a diagnosis. But if the whole list applies to the deal you just bought then “Houston, we have a problem.”

1. Unrealistic Hockey Stick Projections

We all dread that slide at the back of the pitch deck where the management team’s eyes light up. It’s where they show you they will be worth $1B in less than 3 years. And they haven’t even generated one dollar of revenue. Scarier, is when they straight-line expenses. Meaning as the company grows they don’t scale them accordingly. My father once met with a company that said they were going to capture “1% of the market.” He did some quick math and asked if they had a head of HR. They looked at him puzzled and said “No. Why?” My father replied, “Because you’re going to need to hire SEVENTEEN THOUSAND PEOPLE according to your projections.”

2. “If you can’t explain it to a 6-year-old, you don’t understand it yourself” -Albert Einstein

The smartest investors I know ask the simplest questions. Back in 2019, I co-hosted the biggest eSports investment event in Canada. No less than 15 minutes into the presentation, in front of 500 investors, one of Canada’s top brokers who manages $2B asked:

“hey ya guys, this is all great but how do you make money at this?”… the room fell silent… no CEO could answer

No answer is your answer! To this day I only know of 1 public small-cap eSports company with meaningful revenue that can answer this question.

3. How tight is your structure?

Founders who know their worth don’t give stock away ‘willy-nilly.’ We’ve all seen the over-bloated share counts that leave us head-scratching wondering what the hell is going on. Instead of spending endless hours scrolling through SEDAR/EDGAR, I suggest you email the below questions to the Investor Relations person, the investment banker, your investment advisor or whoever sent you the deal:

1) How much $ has been raised in each financing? This will help you determine the average cost basis of the shares. For example, if a big chunk of shares was issued at $0.01 and you are buying at $1. Tread carefully!

2) How much money have founders invested and how many shares were they issued for free? This will help you determine how committed they are or conversely how much greed is in the punch bowl.

3) When are shares coming free trading? You don’t want to buy a stock ahead of a lock-up coming off. There’s different lock-ups on different financings. Ask for a breakdown: # shares, financing price, free trading date. 

Having a lot of shares outstanding is common. But you should know the dynamics involved. Think of it as a game of ‘Whack-A-Mole.’ You want to understand when and where you are going to get whacked.

Rule of thumb: if a company has more than 100MM shares outstanding, is less <1 years old, and it takes 30 minutes and a whole excel spreadsheet with multiple tabs to explain when the ‘lock-up’ comes off (this actually happened to me), tread carefully!

4. CEO constantly marketing not building

“No amount of marketing can make a bad company’s stock go up and stay there.” The best way to get your stock up is to roll your sleeves up and build a business. The CEOs that worry me are the ones who can’t stop marketing. They are flying around the world constantly looking for ‘new buyers.’ The CEOs that don’t worry me are the ones I barely hear from. When I do, their story and pitch decks stay exactly the same. Usually very boring. Take one of my favourite small-caps, Boyd Group (BYD-T), I literally don’t think they have even changed their font in a decade!

5. Frankfurt Listing & German Promoters

There’s nothing wrong with spending money on investor relations. Every company should have a strong one. But, if you see a company spending +20% of their budget on ‘awareness marketing’ and they’ve aggressively hired promoters ahead of their new Frankfurt listing (a promoters paradise), beware! Or all of a sudden you see a bunch of anonymous accounts on Twitter hyping the same company. $CRAP there might be an issue.

6. Management’s History

If the SAME management team has changed the company’s sector multiple times like this – Mining>Crypto>eSports>Plant-Based – run! Please take a deep dive into understanding the team’s past. Failures are fine, it’s hiding them that is not. Back in 2011, we kicked a former founder of Oilexco, out of our office during a pitch. We had lost a huge amount of money on this company. But, that wasn’t the issue. It was that in convincing us to invest in his NEW company he showed us the Oilexco chart, only half of it. He removed the part where the stock nose dove to near zero (eye roll).

7. Fluffy Press Releases

Real companies are too busy building their business to bother with ‘non-material’ press releases. If you have to read a press release several times to figure out if it’s important. It’s not. The company is trying to create ‘hype.’ Material Means = quarterly results, acquisitions, financings, management changes.

8. Luckiest Person in the Room

You are NOT the luckiest person in the room. If you are saying to yourself “Wow I have found a real gem here, and I am the first to hear about it,” please proceed with caution. There’s an old saying “the best oil & gas deals don’t make it out of Calgary.” Experts in their fields who are starting new companies first seed them with their own capital. Followed by friends and family, investment bankers and key brokers. I’ve never made money investing in some obscure private placement from someone on LinkedIn.

9. Me Too

When there’s an emerging theme like psychedelics with tons of money flowing in, avoid the ‘me too’ deals. They usually appear +18 months after the boom has started. They are typically low quality promotes with no real assets. Specifically avoid private deals at this late stage in the game. These deals rarely go public. You will be left with a ‘bag of dead bodies’ like one of my hedge fund friends likes to call them.

10. Get $hit Done Person

Every company needs one of these. It doesn’t have to be the CEO. But, if you notice that the entire team is made up of ex-investment bankers or consultants and no one who has actually built a business, be worried! Building a business is a messy & incessant grind. You need a borderline delusional, obsessive leader with street smarts who can drive the company forward through thick and thin. Make it a game of figuring out if they have one of these!

Always be Compounding.

I hope this list improves your odds of success. Thanks to compounding, a 1% improvement in your investment game a day makes you 37x better by year-end. Remember, small-cap investing is a game of numbers:

“If you are shovelling shit keep going there’s bound to be a pony in there somewhere”

How’s Grit Playing It

The reality is I invest in both. It’s the 80/20 rule for me. 80% invested in REAL small caps and 20% in promotes. Sometimes I don’t know I am in a promote until it’s too late. Sometimes it’s a really good promoter who brings me a deal and it’s the start of a new new emerging theme. So, I dabble.

But, if I am completely honest and tally it up, I’ve lost more than I have won playing the promote game. Nine times out of ten they only work for the dealmakers not the investors.

If you want to know which small caps I own that fall in the “Successful & Real Company “ bucket, please read my newsletter from 2 weeks ago HERE.

“All Great Companies Started As Small Companies. Find Them”

Don’t forget to follow me on Twitter. Where I give daily insights on stocks.

Until next time. Always Yours. Incessantly Chasing ROI,

-Genevieve Roch-Decter, CFA

P.S Bitcoin is now bigger than JPMorgan Chase. AND almost bigger than all 5 Canadian banks combined ; )

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What else we Grittin’ On:

IPO POPS. First day gains are UP significantly in 2020. Because float size is down +50%. Will this trend continue?

TikToK REITs. Mansions with TikTok stars are now publicly traded. Seems frothy.

Digital Theme Parks. “The Most Important Media Businesses of the Future”. Great read as I do my DD on the upcoming Roblox IPO.

AirBnB. Released its S-1 filing to go public. Shocked they actually made money: $219M in profit last quarter.

Who Wears Short Shorts. The Fed has nearly put an end to short selling. Where my favourite short sellers at?