Think Big Investment Opportunities

July 5th, 2007

I’ve often spoke about investing for the long haul and how there are plenty of opportunities on the TSX Venture exchange for small caps with a lot of hidden potential value.  Never once have I mentioned the type of company that makes a good investment.  There are several key characteristics that make some companies a better investment than others. 

There is a revolution going on in the business world, where everyone is told to focus on a niche - a single targeted market and dominate it.  This is a good idea but some companies take that advice too far and focus on market opportunities that are small.  A company can have a niche market, which is fine, but that niche must be big enough to eventually become a multi-billion dollar market, or the company is doomed to remain small even if it is successful.  This brings us to our first characteristic:

The business must be in a market that is very large or has the potential to become large.

A small piece of a big pie is better than a big piece of a small pie.  Why? If you have a small piece of a big pie and the company is successful within the industry, it will be able to continue growth indefinitely.  If it’s a very successful company with a large market share in a small market (let’s say selling canes to seniors) then it will be virtually impossible to grow its market share beyond the capacity that the market size will allow.  It may be fine to be a small business owner and find success within a smaller niche, but for an investment it just isn’t what I’m looking for.

The start up costs should be relatively low.

Simply put, I don’t like investing in start up companies that bleed $xx million a year for five years in the hopes that they will eventually take off.  Yes, there are exceptions based on how big the potential market is and the company’s strategy and proprietary technologies may be a factor.  I’m talking about the average company that bleeds cash for way to long during the startup period. 

I like to see a business that can be started for relative cheap (a few million or less) and then begin to see sales take off.  This is sort of a proof of business concept, strategy and that the product/service is in demand.

A company that generates revenue is a sign that the market demands its service/product.

Revenue generation isn’t good enough… the company must also have decent margins and make some money, even if that money isn’t translating to GAAP net profits.  During the early stages the company may be amortizing many new assets which are resulting in a ‘net loss’, even if the company is experiencing an increasing cash flow.  This brings us to the next characteristic:

Positive cash flow is a must.

After the initial startup phase is complete, it is nice to see a company achieve positive cash flow.  A company generating revenue isn’t good enough unless it is resulting in a positive cash flow.  Without positive cash flow there is only one way a business can grow - shareholder dilution through further rounds of financing. 

You see, it is impossible to invest for the long haul if the businesses that you have invested have achieved about as much success as they ever will due to market limitations.  If they won’t continue growing for years to come, you might as well sell them… and if you sell them the tax implications can hurt your long term investment strategy.  So to recap thinking big about your investment opportunities:

• The company must be in a (potentially) large industry.
• Start up costs must be reasonable.
• Sales should begin taking off as proof of concept.
• Positive Cash flow is a must.

Note: None of these characteristics make a company great, but they make a potential investment great; there is a difference.  I still believe you should invest in great companies that are innovative, creative and strategically brilliant.

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