By Vikas Ranjan
So you want to invest in small cap companies, the ones that typically make up more than 60% of a stock exchange’s list. As a prelude you want to read some research, the kind that is available from scores of different sources for the large Blue Chip names such as RIM or Brookfield.
Well, best of luck at finding this research. It might shock you to find out that the bulk of small-cap companies go uncovered by the large bank brokerages with their myopic focus on the large liquid names. In order to remain profitable, these firms must focus on big-cap stocks to generate highly lucrative investment banking deals and trading profits.
This necessarily leads to a focus on a small number of stocks and leaves over 60% of stocks in the cold as far as research coverage is concerned.
The 60% includes hundreds of junior companies listed on CSE and other exchanges, which are rarely if at all covered by good quality research. For many of these companies it is very challenging to generate investor interest, which in turn makes it very difficult to raise capital at a reasonable cost or to raise it at a reasonable valuation.
Why investment research?
Investment research is important because it seeks to provide necessary information to the market so as to facilitate the right investment decision. As Finance 101 tells us, relevant and timely information is the key to an efficient market. Conversely, a lack of information creates inefficiencies that result in stocks being misrepresented (or over or under valued). Not good for the investor or for the market.
Publicly listed companies are required to maintain an environment of investor confidence through a commitment to keeping the market well informed. On the other side of the coin, investor confidence is backed up significantly by quality equity research.
But that is just one part of the equation. Academic studies in markets around the world have demonstrated time and again that equity research tends to have a positive impact on liquidity − the key measure of stock market activity. This may then lead to a lower cost of equity capital for companies that are well researched.
The Changing Landscape
However, help is at hand from two different quarters. First, independent research firms and boutique brokerage firms are starting to provide research on stocks neglected by major investment banks.
The other avenue that is gaining in popularity as a major source of independent research on uncovered companies is fee-based or issuer-paid research. Fee-based research is research compiled by an independent firm that is compensated by the company being researched. Fee-based research firms work on a model similar to that of the rating agencies. They rate the company under coverage for its investment potential, but as with rating agencies, they receive a fee from these companies.
While on the one hand common sense tells us that investors should toss such paid research aside as promotional, there is a strong indication that users want investment research − paid for or not. In fact, in a survey done by “Investopedia” (A Forbes Media Company), 75% of investors said that legitimate fee-based research is objective and useful and 70% of these investors agreed that companies using fee-based research are making a positive statement about their investment potential. Part of the reason for this may well be that fee-based research houses such as ours, make sure that the reports carry extensive disclaimers and includes a list of the fees received.
There is a reason for such investor reaction. Fee-based research increases market efficiency and bridges the gap between investors who want research (without paying) and companies who realize that Wall or Bay Street is not likely to provide research on their stock. Fee-based research provides information to the widest possible audience at no charge to the reader because the subject company has funded the research.
Can Fee-based Research be objective?
The biggest concern with fee-based research is whether it is inherently biased. Our experience after providing fee-based research is that if done right, a fee-based investment research report can be objective and independent.
Issuer paid research that fairly represents both opportunities and inherent risks associated with a company can be useful and unbiased. Besides, most investors are sharp people and can quickly see through biased material. If a fee-based research provider is not objective, it risks losing credibility and reputation. And not just that, if research is perceived as promotional and biased, it will also negatively affect the credibility of the company being covered.
Fee-based research has had to do some convincing to cement its place in the investment community, but the market is starting to realize that it is a viable and legitimate source of information. The National Investor Relations Institute (NIRI) of USA was probably the first group to recognize the need for fee-based research. In January 2002, NIRI issued a letter emphasizing the need for small-cap companies to find alternatives to Wall Street research in order to get their information to investors. A number of global equity exchanges are now encouraging and even providing fee-based research coverage programmes for their listed companies.
The bottom line:
Increased regulation and consolidation will further erode the ability of the firms on Bay and Wall Streets to provide coverage on most listed companies. Fee-based research then becomes a legitimate alternative to increasingly shrinking coverage offered to small cap companies. Issuer paid or fee-based research is bridging the information gap and empowering the executives of small cap companies to take command and provide quality independent research coverage for their companies. The benefits of this kind of research have become apparent and it is here to stay.
(About the author: Vikas Ranjan is a co-founder and Director of Ubika Research Inc., a fee-based research firm based in Toronto. He can be reached at email@example.com or at 416-605-7024)
About Ubika Research
Ubika Research is a corporate research service available to under-researched micro and small cap companies. With offices in Toronto and Vancouver Canada, it provides an objective and independent investment research service to micro and small cap companies. Ubika’s solutions assist client companies in raising the investment profile and in improving liquidity, valuation and shareholders’ return.
More information on Ubika Research is available at www.ubikaresearch.com
Since 2005 ITB Solutions has provided listings development services to stock Exchanges in Canada such as the Canadian Securities Exchange. ITB Solutions currently provides New Listing Services to the NEO Exchange. We assist companies with the listing application and managing the process to become publicly tradable in Canada, as well as offering advice on how to make the most of your public listing. You can reach Jeffrey Stanger at 647-500-0492 or by email at firstname.lastname@example.org