Scrutinise management when investing in small caps, says expert
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The performance of small caps has a lot to do with whoever is in the top job, says executive chairman of Armytage, Lee IaFraté.
How does management of a small cap differ to a larger organisation?
In a small cap company the Managing Director does it all – they are the key drivers, the real fabric of the stock. When there is a significant change in management, stocks do get put on the watch list.
Regardless of the reason behind it, shareholders are always sceptical and they will question the motives.
When you’re in the small cap space you have to run twice as hard to get attention and be seen to be good than you do if you’re in a big cap – you don’t have the same institutional backing behind you.
History says that when there are changes in management, the market sits back and re-evaluates the new structure. Unlike a larger company that has to comply with bureaucracy, small caps are dictated by whoever is in the top job.
Can you provide examples of the relationship between a company’s management and its stock price?
One we have been watching closely is Paragon Care (ASX:PGC), they recently announced changes to their board as part of a transition strategy and it has seen a dip in their share price as the market re-evaluates itself.
I think they will drift for the next three to six months as the new boss finds his feet — but it is simply a victim of its own growth.
On the other hand, a company like Freedom Insurance (ASX:FIG) has had questions raised as to their management due to a series of sell downs followed by a profit downgrade. Results released in August showed all seemed to be going business as usual and there were large lines of stock being offered continually and consistently.
The stock drifted from around 80c to the 70s and then right on cue management announced a profit downgrade which saw it tank down to 50c.
There have been a lot of questions from shareholders because the move was totally out of sync to what had been advised, despite what was touted as a highly sophisticated accounting system. Armytage wrote a very specific letter to the company, expressing our disappointment at the circumstances — they appear to be able to walk away scot free with managerial behaviour.
In a case like this, investors lose confidence in management and there can be huge question marks in terms of transparency.
Is a change of management enough to get a company back on the right path?
A company that has managed to do so is Onevue Holdings (ASX:OVH). Managing director Connie Mckeage is has come into a tough industry and they have managed to turn the company around to make it a solid success.
It would be easy to be left behind in the tech space and Connie has been a key driver and done a top job.
How can a retail investor differentiate between good and bad management?
One of the sins of being a small cap, is there is only a few people that are the hard engine drivers of the machine. Results revolve around several key staff, and once you lose them, it has a direct impact because of the sheer nature of the organisation.
The things to look out for are focus and hard work – people who are not complicating the story.
In the small cap space you don’t have a massive engine behind you so leaders need to be nimble and hard working.
Are founders the best company leaders or are they too emotionally invested?
Founders that bring businesses to market need to have credible succession planning – they can’t be the only ones rowing the boat.
Board members that are company founders are characteristic of this sector, but by no means a criticism. Investors need always to assess that there is high risk in these businesses in this space.
One of our best successes has been Kogan (ASX:KGN), which remains to have its founders as major principals.
They are in a growth industry but still have to get to that next level in size where they spread that owner/founder risk.
Lee IaFraté has been in the financial industry for over 30 years, with broad experience ranging from stock broking and funds management to principal lecturer at the Securities Institute of Australia. Lee is the Executive Chairman of Armytage.
This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.