My Secret Blueprint for Finding Small-Cap Gems

One out of every five businesses fails in its first year…

And half don’t make it past five years.

Those numbers from the U.S. Bureau of Labor Statistics show why investors should be cautious when investing in newer companies.

But today, investors are pouring money into newer companies – especially as the artificial intelligence (“AI”) craze heats up.

So how should you think about investing in an early-stage business?

In short, you have to be very careful.

Because while Amazon (AMZN), Microsoft (MSFT), and Apple (AAPL) all had humble beginnings, they’re the exception, not the rule. And finding those exceptions can be a time-consuming process.

For example, my Wide Moat Confidential service focuses on these smaller, newer companies that have potential for rapid growth. My April recommendation was a nationwide company that saw its share price drop by more than 50% in a 12-month span… leaving it further in smaller-cap territory than it has been in decades.

This is a company that I happened to have plenty of experience with. I actually built many of its stores back in my developer days. So I was in a great position to research the company and realize that it was in the midst of a turnaround… and recommend my readers pounce on its overly beaten-down stock.

The result has been an almost 50% gain in about six weeks!

So today, I’d like to share the evaluation process I follow when selecting small-cap companies. It’s one that has served me – and my Wide Moat Confidential subscribers – quite well.

It’s all about taking due diligence to the next level whenever and wherever I can.

Sorting Out the Deals

There are a few thousand small-cap companies – defined as having market caps between $300 million and $2 billion – listed on the New York Stock Exchange (“NYSE”) and the Nasdaq. Many more exist on other indexes, but you automatically cut your risk by narrowing your search away from over-the-counter (“OTC”) markets.

Even then, there are still a lot of small caps to go through. So I’ve put together a screening tool that allows me to identify shares trading at a wide discount. And each month, I pull 25 of these companies that are especially intriguing.

This is an invaluable tool that yields the bulk of my eventual recommendations. And I also stay active on social media platforms such as X, LinkedIn, and Substack. Several of Wide Moat Confidential‘s current positions have come from these sources – including a little-known asset manager and a jet-hanger landlord I’m especially excited about.

Regardless of how I come across a potential pick, though, my next step is always to see if I can put my boots on its ground. I want to get as up close and personal with these businesses as possible.

This is always a helpful practice with any investment research project, and it’s especially important with less-established small caps. The smaller the track record a company has, the less online research I’m able to do.

There are fewer numbers to crunch and shorter track records to analyze. So seeing, hearing, tasting, and even perhaps smelling their operations in person can help fill in at least some of those blanks.

For instance, before recommending the jet-hanger business, I spent considerable time visiting its properties… speaking to its customers… and attending trade show conferences it participated in.

And now that I’m analyzing a real estate firm, I’m lining up visits to some of its properties in Las Vegas, Texas, and Arizona. Hawaii, too.

(Hey, I never said there weren’t perks to the job.)

Now, I realize that this kind of travel might be imprudent for many of you. And unfortunately, there’s no real substitute for a good boots-on-the-ground effort.

But perhaps you have contacts in the industries your small-cap interests work within. Or maybe you have trusted family members or friends who live by these businesses who can provide some insights.

Better yet, your “backyard” might feature some worthwhile investments. I recently recommended my local grocer, for instance, and I’m very pleased so far with its progress.

Management Matters

Another crucial small-cap detail I always make sure to investigate is management.

Who’s running the show? What kind of experience do they have? What is their vision? Those are the kinds of questions I aim to ask.

This can obviously be done online, but I once again like to take the extra step of meeting management directly.

I’ve conducted my fair share of Zoom meetings for these purposes, especially during the shutdown era. But I like it best when I can meet C-suite members in person… which is exactly what I’m doing now in New York City at Nareit’s “REITweek.”

This annual conference is focused exclusively on real estate investment trusts (“REITs”). REIT management, experts, and investors descend on New York City for a three-day whirlwind event that’s exhaustingly informative.

I’ll be attending as many sessions as possible in between sitting down with more than two dozen CEOs. There’s always a lot to share afterwards, and I can’t wait to see what this year yields!

REITweek or not, I come to each interview with my due diligence done, a list of questions, and an attitude of professional skepticism.

I know management’s job is to sell me… But my job is to only recommend you buy if it’s worthwhile.

The ideal small-cap company is one with a management team that’s busy executing and establishing a wide economic “moat” to protect its profits. That’s an impressive feat I’m automatically drawn to.

It’s one of the main reasons why I pulled the trigger on that previously mentioned jet-hanger stock. Management there is busy utilizing attractive debt through public bonds at a 5% interest rate – allowing it to grow from an attractive cost of capital that’s generating sustainably high free cash flow.

There really are amazing small-cap opportunities out there that can grow their businesses and your profits so much more quickly than their larger competitors. You just have to sort through a few hundred “never going to make it” companies to find the gems.

Or better yet, let me do it for you…

We don’t have an online order form for our Wide Moat Confidential service, but if you’re interested in our Wide Moat approach to finding small-cap stocks with the potential to double in 12 to 18 months, call 888-501-8530 between 9 a.m. and 5 p.m. Eastern time.

Regards,

Brad Thomas
Editor, Wide Moat Daily