A swathe of microcaps put in some truly remarkable gains last year. The share prices of Bubs, Jervois, and MyFiziq increased 12, 16, and 30 times respectively, and there were scores more that tripled or quadrupled. Yet many of these stocks have business models at very early, or even conceptual, stages, and little, or zero, revenue. 

While most of today’s most promising midcaps started with similar modest origins, for each one of those flyers, there were 99 other flameouts. With one of last year’s biggest-gaining concept stocks, GetSwift, now in the spotlight for the wrong reasons, we asked three seasoned specialists to share some practical steps to separate the flyers from the flame-outs. 

Take your time... and ask lots of questions

Tim Hannon, Newgate Capital

The first step is to take the time to understand the product the company is developing and marketing. 

Ask a lot of questions:

• How does it create value? 
• What incumbent product or existing work practice is it displacing?
• How will customers know how to use it? 
• How much would they be willing to pay for it? 

Importantly, this inquiry process should ignore the hype, motivational slogans, promises and ‘vision’ statements from the company.  These are distractions.  The starting point is to put yourself in the shoes of the company’s customers – they ultimately define the value of the product, not the company.

The next step is to assess the company’s strategy. Determine how the company intend to marshal its limited resources to meet the challenge they face. Determining the skills and credibility of the Executive and Board is critical here: do they have what it takes to execute the strategy?

This is often a very difficult assessment in the early stages of a company’s life because there is no specific track record specific to assess. 

We recommend if you are unable to make a confident judgement at this point, simply adopt a wait and see approach until you can. 

And this is our summary advice for investing in early-stage companies: Take your time and asks lots of questions. 

Management, monetisation and validation

Oscar Oberg, Wilson Asset Management

When it comes to assessing concept stocks, we focus on:

1. Management
2. Monetisation of ideas, and
3. Validation

Management

First and foremost we look at the people behind the business. A strong management team and board with a track record of success is critical to the future performance and profitability of the business.

We consider what interest the management (and founder) has in the business. Managers with ‘skin in the game’ have exposure to the performance of the company, aligning their interests with shareholders and creating an incentive to perform.

Monetisation

The concept must also be on a clear pathway to profitability with regular market updates demonstrating proof of concept, with momentum in cash receipts.

Validation

Endorsements by credible third parties, for example a partnership agreement with an established business or a high-profile investor on the register, provides validation of the business model. For example, EBOS’s stake in MedAdvisor could be viewed as a positive for the company and offers an endorsement of the business model.

Other relevant factors to consider include the business’s competition and barriers to entry. 

Investing in credible ideas … or punting on momentum?

Harley Grosser, Capital H 

Firstly, I think you have to come at it with a healthy dose of scepticism since the large majority of these concept stocks will either never achieve a level of success necessary to justify their valuation or in many cases won’t survive at all.

Secondly, I think is important is identifying whether you are investing in a concept you believe has a good chance of success, with the research to back it up, or just trading momentum stocks.

Most of the popular ‘concept stocks’ today are mainly attractive because of the enormous momentum in their share prices. Fear of missing out seems to grant investors with an uncanny ability to come up with far-fetched theses on why these companies will be giant killers. Reality is however, less exciting.

I’m certainly not against buying these early-stage companies, and a lot of money has been made in the last 12 months, but we need to recognise it is hard to do it well - a lot harder than the current market environment is suggesting.