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Investing in small cap stocks
1. Small Capitalisation:
Investorโs Guide
Seeking alpha from junior stocks.
CHF Investor Relations, February 2011
2. What defines a small cap stock?
Serves a niche market.
Serves emerging high-growth markets.
No dividend, or little dividend.
More thinly traded than large caps.
Little analyst coverage.
3. What is the size of junior stocks?
Capitalisation of S&P/TSX Venture Composite
Average: $ 90 million
Largest: $ 810 million
Smallest $ 10 million
Median $ 50 million
Micro-cap: Less than $10 million
(not included in the index)
What is their return?
S&P/TSX Index (large caps) in 2010 : 14,45%
CHF clientsโ shares in 2010: 56,6%
4. Analyst coverage in the mining industry
Number of analysts per size of company
16
11
6
3
2
1
<25 25-50 50-100 100-250 250-500 >500
Market Capitalisation (C$million)
Source: capital IQ/TMX
5. For the 50-year period ended December 31, 2009, $1.00 invested
in large-cap stocks would have grown to $80; the same investment
in small-cap stocks would have grown to $226.
Why are returns superior?
Sources: Center for Research in Securities Prices, University of Chicago 1957-1993; Standard & Poorโs, 1957-2009. Large-cap stocks are represented by Standard & Poorโs Composite Index of
500 stocks, an unmanaged index considered representative of the U.S. large-cap stock market. Small-cap stocks are represented by the Center for Research in Securities Prices 6 th-8th Decile of
New York Stock Exchange from 1957 to 1993 and the S&P SmallCap 600 Index from 1994 to 2009, unmanaged indexes. Past performance cannot guarantee future results. Individuals cannot
invest directly in any index.
6. Market mispricing
The market often misprices small capitalisation stocks due to lack
of availability of information on companies since there is little
analyst coverage.
Poor liquidity also keeps away some investors resulting in lower
valuations.
However, as the company grows and builds momentum, the
mispricing is reduced as a result of increased interest from
investors and analysts. Value also comes from take-overs as
these companies become targets for larger firms.
12. Canadian small caps
Mining Exploration Oil & Gas Biotechnology
Mining Production Green technologies Other Industries
13. Mining is by far the largest industry on the TSX venture. We will
therefore spend some more time discussing investments in this
sector.
14. Mining markets at a glance
December 2010
TSX Venture TSX
Number of issuers 1,178 353
Total market capitalisation 42 billion 520 billion
New listings 149 59
Equity capital raised 5,3 billion 12,5 billion
Number of financings 2110 303
Volume traded 46 billion 45 billion
Value traded 22 billion 393 billion
Number of trades 6.5 million 67.6 million
Source: TMX December 31, 2010
15. The Mineral exploration development cycle
Theory:
This chart shows a theoretical share price progression from
discovery to production from a successful discovery.
Start of operations
Confirmed deposit
Reality sets in
Production decision
Share price
Discovery Development Production
Speculation Investment analysis Revaluation
Source: Financial Times, The Gold Book, by Pierre Lassonde.
16. The Mineral exploration development cycle
Theory
โขTowards the end of the first exploration phase, resource, scoping and pre-
feasibility studies will be completed.
โขThe pre-feasibility study point in time comes close to the peak in
speculation.
โขStocks usually decline as the feasibility study is being tabled as
โขreality sets in.
โขStocks are typically weak after the feasibility study, as a production decision
is made and financing is sought โ mine construction would take up to 2
years.
โขStock prices should start to rise as production starts to become a certainty โ
once in production stocks generally continue to rise as risk is removed and
earnings commence.
17. The Mineral exploration development cycle
A real life example: Monument Mining Ltd (TSX-V:MMY)
Commercial production announced
18. Why is a non-producing mineral property worth anything?
19. Why is a non-producing mineral property worth
anything?
Non producing properties represent potential for
eventual mineral production through:
โขExploration discovery
โขEnhancement of existing mineral resources
โขImproved circumstances
โขNew ownership
A market exists for non-producing mineral properties.
21. What is a NI 43-101?
It is the National instrument 43-101 of the Canadian Securities
Administrators.
It sets standards of disclosure for mineral projects.
It governs resource and reserve estimates, also all exploration
information that comes out by news releases.
Four fundamental demands:
โขMake disclosure of the responsibility of a qualified person.
โขFully disclose all relevant information, including data quality.
โขUse recognised definitions for resources and reserves.
โขIndependent reports at trigger events like resource estimates and
economic assessments.
22. Resource and reserve definitions
Level of knowledge Resource Reserve
Closely spaced drilling, virtually
certain of size and grade Measured Proven
Mainly closed drilling, adequately
certain of size and grade Indicated Probable
Stepout drilling, size estimated on Not a
assumption of geological continuity Inferred reserve
23. A good project, key indicators
Good ore body: Large reserves, high grade, low strip ratio.
Mining-friendly jurisdiction: Stable politics, predictable and timely
permitting process, existing mining operations, attractive fiscal regime.
Infrastructure: already exists or being built: power, transport, water.
Quality of Management: knowledge in mining? Ability to make deals
for long-term development? Board and corporate governance.
Technology: proven extractive technology of ore type.
Economics: Low expected cost of production.
Potential for future expansion.
Commodity: Does the commodity in question have a positive outlook?
24. Where do small cap stocks fit in a portfolio?
Some clues.
25. Who can invest in junior stock?
Since junior stock carry a higher risk of market
fluctuations, they may be appropriate for investors
with a long investment time frame who hold a well-
diversified portfolio.
In some cases, the regulators require that only
high net worth investors be invited to participate in
financings.
Some junior stock can be added in a portfolio for
tax purposes on financing for flow-through shares.
26. Growth strategies
Allocating a small portion of the portfolio to small
cap stocks.
Careful selection: given the lack of research on
small cap stocks, it is of the onus of the
broker/portfolio manager to carry out a due
diligence.
Some stocks will soar, others will lag. The objective
is to target an average return.
27. Growth strategies
Return
Stock A 150%
Stock B 100%
Stock C 50%
Stock D 30%
Stock E 0%
Stock F 0%
Stock G 0%
Stock H 0%
Stock I -20%
Stock J -40%
Average 27%
28. Growth/value stocks
Small caps can change from growth to value, requiring
adjustment in portfolios. Example: Foraco (TSX:FAR)
Growth period: Growth stalls Value
Acquisitions Adjustment investors
Buy market share step in.
Stock:+150% Stock: -20% Stock: +25%
29. Tax strategies: flow-through shares
The investment in flow-through shares is deductible from the
investorโs taxable income.
These shares are only available upon rounds of financing.
The issuer has an obligation to spend the funds in exploration
activities. Administrative costs are not allowed.
Example: $
Initial investment: 100
Investor's marginal tax rate: 40%
Tax credit (= 40%x 100) -40
Net cost of investment 60
Risk: a rush to invest in flow-through shares irrespective of the
fundamentals of the issuing company can lead to a net loss.
31. CHF Investor Relations thanks you for your attention.
We would be happy to introduce you to small cap companies.
For more information, feel free to contact:
Anne Robert
Account Manager
Tel: 514 510 6338
Cell: 514 826 8121
E-mail: anne@chfir.com
