I cut this out of an article in this months Individual Investor.
iionline.com
A small company also needs cash in order to leap forward, but it's not uncommon for one to have less than $100,000 in the bank. Cash flow, an important sign in the case of all companies, takes especially careful scrutiny with microcaps. "Frequently microcaps have grandiose plans, but they need cash flow to fund their efforts," says Davis of Napeague. Cash flow from operations, the first category on the statement of cash flows, indicates whether the company's current business is sustainable, and Davis closely watches the way in which microcaps finance growth, detailed in the second category. (Warrant conversions, for example, may provide much needed money, but they dilute net income.) If a microcap doesn't have a lot of cash on hand-check the first line on the balance sheet-and doesn't have positive cash flow from operations, it may have to issue more shares to raise money. That is also dilutive.
Ultimately, though, issuing shares in a secondary offering might not be such a bad thing. After a secondary, analysts from the underwriter will typically pick up coverage, and nothing gets a microcap moving like new sponsorship. Stock prices, of course, depend on supply and demand, and no matter how great the fundamentals of a company, people have to want to buy its shares. For investors to want to do so, they have to have heard about the company. Without sponsorship, that's unlikely. "The market perceives stocks with less information as riskier," says Bogle of n/i. That means if you have two companies with identical fundamentals, the one with less sponsorship may be priced lower. "It's the market's way of saying you have to give me some incentive," says Bogle.
Although there are now forms of sponsorship other than Wall Street analysts, they present pitfalls for the microcap investor. Print newsletters and Internet bulletin boards and chat rooms can help get a stock's story out. But they also open the door to manipulation. "It's tough to find truly unbiased information," says Jeff Grossman, editor of The SmallCap Investor Web site, who points out that many newsletters are compensated to issue buy recommendations. Keep your eye out for disclaimers such as this one that accompanies The Future Superstock, an Internet newsletter. "Companies featured by The Future Superstock publication pay consideration to The Future Superstock for the electronic dissemination of company information and, in some cases, for consulting and/or Web site development."
As for timing, investors have different approaches. Some won't buy a microcap unless they can identify a catalyst that will push shares higher; earnings growth alone isn't enough. In the case of a biotech, an indication that its drugs work could be a sufficient stimulus. For service companies, perhaps a big contract will do the trick. But other microcap investors relish getting in on the ground floor. The key, of course, is that the floor be solid. "If a small company continues to be successful, analysts will become more interested," says Oberweis. "I love to be there first."
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