Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 202

Corporate activity helps build a small cap portfolio

A common theme of investing in small cap stocks is limited liquidity, or in other words, difficulty acquiring or selling stock. This can naturally present a challenge for those on the outside looking in (and even those on the inside looking out). Investors can be left scratching their heads as to how an equity fund manager has built a significant stake in a particular stock given its limited trading volume.

This article outlines the corporate opportunities presented to fund managers and some key points for retail investors to position their portfolios towards higher quality small-cap stocks and management teams.

 

Rights issues

Rights issues allow companies to raise funds without penalising existing shareholders. Raisings are typically done at a decent discount where existing shareholders are invited to purchase additional shares in the company. For small caps, rights issues are usually non-renounceable, that is not tradeable, which means liquidity might not improve as the rights are tied only to existing shareholders. However, any underwriting of a rights issue shortfall provides a way for new shareholders to access shares which is effectively a placement of rights which are not taken up by existing shareholders.

Key point: watch for management and substantial shareholder involvement. If they are not prepared to take up their rights in full, then consider, why should you? Is the offer accelerated or not? If not it can have a drag on the share price.

 

Placements

Placements are the bread and butter of growth capital in small caps, often providing the most effective entry point for a fund manager to gain meaningful positions. Placements may be done in conjunction with a share purchase plan (SPP) which provides all existing shareholders the ability to subscribe for up to $15,000 worth of stock under the same terms as those participating in the placement. We like it when companies offer an SPP as it shows they are treating all shareholders equally.

Key point: for a retail shareholder when deciding whether to participate in an SPP, consider these two red flags; firstly, is the placement only for working capital purposes? Secondly, is the placement occurring at a price lower than a previous placement?

 

Private placements

A private placement is when a company conducts a share transfer to one particular shareholder. Typically, this will occur either to a strategic investor or to a fund manager who is unable to buy the desired share parcel on the market. Private placements are encouraging for investors and they shows that someone is willing to be the only party providing growth capital and are therefore likely to be a long-term investor.

Key point: is the placement a transfer of existing shares from a large shareholder or new equity raised? We prefer seeing new equity private placements as it shows key shareholders are not cashing out and it provides the company with growth capital.

 

Sell-downs

As a rule of thumb, if directors or management are selling, external investors should not want to buy. There are however exceptions where it can prove to be a highly effective way of improving liquidity, attracting institutional investors and improving the business profile within the market.

A sell-down should be judged on a case by case basis, and questions to ask include:

 

 

  • Who is selling down, why and how much?

 

  • What is the cash balance of the company?

 

  • Is this the best way to improve liquidity?

 

  • Are they likely to require a capital raising short term?

 

We like to see a strong management track record or share price returns and organic growth before we consider participating in a sell down.

Key point: be sceptical where you see a manager sell-down to exit their full position, as skin in the game is paramount for quality small caps.

 

IPOs

Investors can be right to ignore a small cap IPO, as the business can be ‘dressed up’ for sale and a prospectus can only tell you so much. You are unlikely to get a good read on how successful management has been on actuals vs forecasts in the past, and this can create a high level of downside risk.

Unlike a private placement or sell-down, IPOs tend to be more widely spread to participating investors. This means fewer ‘long-term hands’ and more ‘short-term hands’ will receive stock. Furthermore, a lot of the time you are either paying down debt or funding an individual cashing out. In any good quality small cap, you don’t particularly want to be funding either of those.

Key point: take a long-term view. Would you be happy to own shares in this business for three years or are you just banking on a short-term trade? If the latter then you’re probably not the only one and the optimism might not translate to reality.

 

Advice for retail investors

You can learn a lot from the actions of a company’s board, management, and key shareholders. How they conduct their corporate activity can give you confidence or otherwise in their long-term thinking. A healthy amount of scepticism can prove a valuable commodity when picking stocks.

 

Robert Miller is a Portfolio Manager at NAOS Asset Management. This article is general information, it is not intended as financial advice and does not consider the circumstances or investment needs of any individual.

  •   18 May 2017
  •      
  •   

 

Leave a Comment:

RELATED ARTICLES

Is now the time to invest in small caps?

Small caps are compelling but not for the reasons you might think...

Hold fire on your fund manager over short-term declines

banner

Most viewed in recent weeks

The growing debt burden of retiring Australians

More Australians are retiring with larger mortgages and less super. This paper explores how unlocking housing wealth can help ease the nation’s growing retirement cashflow crunch.

Four best-ever charts for every adviser and investor

In any year since 1875, if you'd invested in the ASX, turned away and come back eight years later, your average return would be 120% with no negative periods. It's just one of the must-have stats that all investors should know.

LICs vs ETFs – which perform best?

With investor sentiment shifting and ETFs surging ahead, we pit Australia’s biggest LICs against their ETF rivals to see which delivers better returns over the short and long term. The results are revealing.

Family trusts: Are they still worth it?

Family trusts remain a core structure for wealth management, but rising ATO scrutiny and complex compliance raise questions about their ongoing value. Are the benefits still worth the administrative burden?

13 ways to save money on your tax - legally

Thoughtful tax planning is a cornerstone of successful investing. This highlights 13 legal ways that you can reduce tax, preserve capital, and enhance long-term wealth across super, property, and shares.

Our experts on Jim Chalmers' super tax backdown

Labor has caved to pressure on key parts of the Division 296 tax, though also added some important nuances. Here are six experts’ views on the changes and what they mean for you.        

Latest Updates

Investment strategies

Warren Buffett's final lesson

I’ve long seen Buffett as a flawed genius: a great investor though a man with shortcomings. With his final letter to Berkshire shareholders, I reflect on how my views of Buffett have changed and the legacy he leaves.

Property

The housing market is heading into choppy waters

With rates on hold and housing demand strong, lenders are pushing boundaries. As risky products return, borrowers should be cautious and not let clever marketing cloud their judgment.

Investment strategies

Dumb money triumphant

One sign of today's speculative market froth is that retail investors are winning, and winning big. It bears remarkable similarities to 1929 and 1999, and this story may not have a happy ending either.

Retirement

Can the sequence of investment returns ruin retirement?

Retirement outcomes aren’t just about average returns. The sequence of returns, good or bad, can dramatically shape how long super lasts. Understanding sequencing risk is key to managing longevity risk.

Strategy

How AI is changing search and what it means for Google

The use of generative AI in search is on the rise and has profound implications for search engines like Google, as well as for companies that rely on clicks to make sales.

Survey: Getting to know you, and your thoughts on Firstlinks

We’d love to get to know more about our readers, hear your thoughts on Firstlinks and see how we can make it better for you. Please complete this short survey, and have your say.

Investment strategies

A framework for understanding the AI investment boom

Technological leaps - from air travel to computing - has enriched society but squeezed margins. As AI accelerates, investors must separate progress from profitability to avoid repeating past mistakes.

Economy

The mystery behind modern spending choices

Today’s consumers are walking contradictions - craving simplicity in an age of abundance, privacy in a public world. These tensions tell a bigger story about what people truly value and why.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.