Assessing my sold off micro-cap
ITKG…a case study
I have been trading, advising and investing in micro-cap stocks for over 20 years and it's made me much more money than I deserve. I've also watched a lot of people lose a lot of money and lose a lot of sleep playing in the micro-cap space. The stereotypical micro-cap investor is an interesting breed and have traits that lead them to poor investing decisions. These traits usually lead to a loss of money. Let me be clear, most people lose money investing in micro-caps and I will explain why, and then how to turn those losses into gains. In today's volatile market, opportunities abound, but it's in markets like these that most micro-cap players lose.
To determine if you're a stereotypical micro-cap investor, answer these questions:
- The stock you're investing in will change the world.
- This one investment will make you rich beyond belief.
- You don't know the difference between a 10-Q and a 10-K.
- When the stock goes up you buy more, because you know it will keep going up and never go down and you don't want to miss out.
- When the stock goes down, you either sell or you want to, because you know the stock will never go up again, so you better get out before it's too late.
- You read various message boards at least once a week.
- You don't know the market cap of the stock you're in.
- You're emotions go crazy when the stock moves up or down.
- When the stock is going down, then something must be wrong with the company.
- When the stock is going up, everything must be good with the company.
- You have called or e-mailed the company at least once in the past year.
- You don't know what an empty shell is.
- You're not sure what "convertible" means.
- You always put in market orders.
- You don't know it the company has a board of directors.
If you answered yes to two or more of these questions, then you could probably benefit from reading this.
First of all, as I mentioned earlier, most people lose money in micro-caps, but there is the opportunity to make huge returns. There are many reasons for the above to occur, such as empty shells, bad management, bad ideas, herd mentality, scams, pump and dumps and poor investment decisions. You can't eliminate all risk, but you can eliminate some, and minimize the rest. Given the current state of the market, I will focus on how to assess your current micro-cap holdings and what you should do with them.
I will start with "The Story". The reason most of us invest (I do mean invest and not trading) in a micro-cap is because of a compelling story. A drug that can potentially cure cancer, a tech product that everyone will have to have, the next social media craze and so on. During a sell off, it's easy to forget why you bought the stock in the first place. The first thing you should ask yourself is, "Is the story still compelling?" or "Has something happened to change the story?"
Has management changed recently? This could be a good or bad thing. Often times, a management change could be just the catalyst a company needs or it could also be a negative.
Did the company recently do a significant capital raise? Your answer can be found by reading the filings at SEC.gov. All too often a company will receive much needed funding but it may come at the cost of the share price.
Has the company gone completely silent? I don't mean the PR's have slowed down, I mean the company is shutting down. I've seen numerous occasions where stocks continue to trade and for all practical purposes the company has ceased to operate. Check company addresses, phone numbers etc. and if they don't check out then you've probably got a problem.
Is management consistent? It is common for micro-cap management to panic in the middle of a downward trending stock. You'll often see press releases or letters to shareholders telling them something great is about to happen, or they've come up with something new that will reverse the present course. This is not what management should be doing, as you want them to be laser-focused on the business and building the company you invested in. They shouldn't be making business decisions based on the movement of the stock. If you see a company that is reactionary to share price, you will most likely see a company that will not succeed.
Is the company progressing? Unless you're a daytrader, look past the day to day gyrations of the stock. Is the company moving forward? Ultimately, this is what will determine the share price. Try and take a step back and look at the big picture. Don't get caught up in the moment. If the share price is way up and the company isn't progressing, you should consider selling. If the price is depressed but the company is progressing, you should consider buying more. Do not make your buy, hold or sell decision solely based on the price of the stock.
When the stock you own is going up and you couldn't feel better about it, it's probably getting close to the time to sell some and when the stock is trending down and you just can't take it any longer, it's probably time to buy some. The reason that most micro-cap investors lose money is because they buy high and sell low. It's just that simple. As they get caught up in the excitement of a stock trending up, they buy on the way up and then they get caught up in the fear of a stock going down and they sell. This is a recipe for losing money every time. Check your emotion at the door and buy low, sell high.
Don't pay attention to stock message boards. I do on occasion post on various boards, but it is purely for factual content purposes, trying to leave sentiment aside. If you read or post regularly on message boards, chances are you're asking for trouble. The chat rooms are filled with basically zero facts and serve no purpose other than escalating emotions. They're basically all the same. When a stock is trending up, the boards come alive with supporters and excitement builds. You'll of course always have persistent trolls when the stock trends down, as they come alive while shareholders are quieted. The conversations only increase the herd mentality and if you are regularly on these boards, your chances of buy high sell low increase dramatically.
One example in the current market is Integral Technologies, (OTCPK:ITKG). Integral is a company that I have followed and supported for the last few years. This stock could be used as a case study in micro-cap investor behavior. For those not familiar, ITKG has been around for 15+ years. They are in the business of conductive plastic. Until recently, they have had zero revenues and they have a very loyal group of shareholders. ITKG has experienced a steep sell off the last few months. The last 12 months have seen extreme volatility. It started 2015 in the mid .40's, hit a multi-year high of .84 in April and closed Friday at .37. Yes, it has been quite a ride and was partly a victim of its own success. The stock has tremendous liquidity. Early last year, it was trading as much as $1,000,000 in volume. This of course makes the stock an ideal target for the trading community. For example, the stock has been on and off the "Tim Sykes recommended list" several times over the last couple of years. This of course gives an added dose of volatility not associated with the normal micro-cap investor.
So let's step back and take a look at Integral the company using the process I outlined above.
Is the story still compelling? I would say yes. The foundation of their story is light-weighting and this trend is not only still growing, but is likely to increase in growth. The Paris Agreement now insures a global effort to improve the environment. Further emissions regulations will only increase the electrification of transportation, which fits perfectly with Integral's product, ElectriPlast. Also, the recent advancement of ElectriPlast into batteries further adds to a compelling story. So, in assessing ITKG, "the story" still checks out.
Has management changed recently? In the case of Integral, it has remained the same for the last 3 years. Management has been consistent. They continually state that the conductive plastic market is huge and they are executing a plan to be prepared for that. I haven't seen the company overreacting or panicking during the last few months either. Contrary to the chatter and the sentiment, what I'm seeing is a company doing what they set out to do. One problem I see though, is a CEO that communicates a little too much and micro-cap investors don't know how to handle that. I will clarify, Integral holds quarterly calls and on those calls there is Q & A for anyone. I listen to a lot of conference calls, but I've never listened to one where shareholders are able to ask anything they want. The CEO & CFO respectfully answer each question to the best of their ability. It is clear they are answering as detailed as possible and this is where I see the problem. He tells it like it is, as he should, but investors don't listen, create their version of reality or just don't understand how the world works. A few examples: The Integral CEO over nine months ago said something to the effect that he expected the assurance of global commercialization in 4-6 weeks. Well, 6 weeks passed, it didn't happen, so the CEO came out and said it didn't happen as expected, but it was still in the works and 9 months later is still hasn't happened and seems to be all the chat rooms can talk about. This is an example of investors not understanding how the world works, most companies miss timelines. How often does Apple miss an iPhone roll out or Tesla well over a year late on a new model roll out? This is how the real world works. Companies do their best to give expectations, but many times things get in the way…that's how it works. If a company never addresses a missed timeline then that is a problem. Integral also issues a monthly newsletter. Recently it was stated in the newsletter that the material information and updates would not be provided in the newsletter, so, you guessed it, the next newsletter comes out and people complain that there is no update in the newsletter…an example of not listening. These things are not unique to ITKG, the same type things plays out in nearly every micro-cap I've ever invested in.
Is the company progressing? In ITKG's case we need to take a look back 3 years ago when the current CEO took control of the ship. Prior to that, the company had zero revenue, no public relationships, a stock in the low .20's, a balance sheet that showed them bankrupt on paper, a board made up of the two co-founders and toxic preferred shares that allowed the co-founders to control the company, regardless of what the common shareholder or management wanted. So, what I'm saying .... this is the exact type of micro-cap you should not invest in. It had a great story, but everything else was a shareholder disaster. It's amazing that so many people poured as much money as they did into a company with a structure like this.
Since then, the company has had revenue each quarter for over a year(small but it's there), they now have relationships with BASF, Delphi and Hanwha, the toxic preferred shares are gone, they have an independent board, the balance sheet is much better and just a few months ago they announced their largest order ever. So yes, they continue to progress. Not as quickly as I, management or shareholders would probably like, but they continue to move forward. The other thing that has been overshadowed by the missed timeline on "global commercialization" is the fact that the company continues to deliver on everything they said they would. I checked through the transcript of the last several conference calls and have not found an instance where the company hasn't done what it said it would do. The original timelines are often a bit optimistic but they also come through or address the fact why they haven't.
Has the company recently done a significant raise? Integral has not, but they have entered into a couple of convertible notes. None are due for conversion yet, but this is something to pay attention to. Current management has done a great job in the past managing convertible debt.
Has the company gone silent? Not in this case, as shareholder relations continue to take calls and I have had people go by their office in both Evansville and Canton.
Emotions: As I mentioned before, emotions are a killer in investing. Let's remove emotions for a moment and take a look at ITKG's stock since the current CEO took over. ITKG has significantly outperformed the S&P, AAPL, IBM and numerous other stocks and indexes in that period of time and during that time there were many instances where you could have more than doubled your money. You would not have doubled had you waited to buy at the top. ITKG is very interesting now, as on Friday it traded briefly at .26 cents. By the way it happened, I'm sure it was a stereotypical micro-cap investor selling low and how do I know this? It was a market order. After that trade, the stock moved up and closed at .37, with the bid at .365, so the guy trading out at .26 left .10 on the table. Why Friday was compelling is because ITKG appears to be bottoming. It may take some time to bounce, but history has shown when it does, there is significant upside. This is the chance to buy low sell high, which most micro-cap investors amazingly avoid. I'm not saying ITKG will be going to $10 or $20, as I highly doubt it ever will, but the situation is now present, whereby it looks like an opportunity for above average returns.
Chat rooms/Message boards? Yes, ITKG has active chatrooms and it's always the same garbage that is passed around in most chat rooms, such as personal attacks, racial slurs, I told you so's, whacky theories, name calling, you know the routine. Feel free to check in to be entertained as to how 5 year olds behave, but make your investing decisions based on your due diligence and common sense.
Micro-caps can be a fun, very profitable experience but you must be smart about it. A few last tips:
- Do not let emotions get the best of you. Most of the time you should be taking action opposite of your emotions.
- Don't put too much of your money into these stocks, as even the best run micro-cap companies have volatility.
- Don't be scared to sell a little on the way up. If you feel it will never go down, then it's probably about to. Take a little of the table…it's okay.
- Don't be scared to sell when it's down. If you feel it will never go up, then it's probably about to. Be sure and go through the steps above first.
- Educate yourself a little on financial statements. A lot of micro-cap balance sheets will look lousy, that's part of it, but some of them are scams or on the verge of bankruptcy and these are avoidable.
- If a company has conference calls, listen to them or read the transcripts. Most don't have them but those that do, pay attention to them.
- The stock action of a micro-cap often times has little or nothing to do with what's going on at the company. This is where the opportunity is! When it is selling off when things are going well…buy. When it's going up just because of momentum…sell some.