Companies that are unable to support their growth with their own cash flows must tap stock and bond markets periodically to raise fresh capital. That dilutes existing shareholders or delays profits. Here's an example. Let's say a company has 5 million shares outstanding at $20 a share... or a market cap of $100 million. If the company needs to raise $20 million, it can issue 1 million new shares at $20. That would dilute existing shareholders by 20%, since there would then be 6 million shares outstanding instead of 5 million. But look what happens if the share price declines to $5. To raise $20 million, it now must issue 4 million new shares. That would take the total number of shares outstanding to 9 million, a far greater dilution. That's a big reason why small, unprofitable companies get such a haircut in a down market. But here's the good news... This reality is already reflected in share prices. It's a big reason why microcap stocks have lagged in this bull market... so far. It's also important to remember that many of the market's biggest gainers over the past few decades - companies like Amazon, Tesla, and Netflix - saw their biggest gains before they ever earned their first dollar of profit. Investors could see that blockbuster sales growth would eventually turn into powerful earnings growth. So they bid the shares up in anticipation of big profits down the road. I expect the same thing to continue to happen in the months ahead, as microcaps with double- and triple-digit sales growth - but no profits yet - bounce back in a big way and turn in a bravura performance. This is especially true with Fed rate cuts on the way. As Ed Yardeni, president of Yardeni Research, points out in this week's Barron's, not only are valuations more compelling with small companies, but many of them have floating-rate debt. That means they stand to benefit the most when the Fed cuts rates. And the bigger the drop in rates - and the longer the central bank eases - the more appreciation we should see. In short, historical outperformance, low valuations, and a looming rate cut all point to microcaps as the asset class that should deliver the greatest outperformance in the months ahead. Smart investors will position themselves now for the turnaround that almost certainly lies ahead. And if you're interested in attending my Emergency State-of-the-Market Summiton the matter, click here to RSVP now. (Clicking the link above automatically registers you for the Alexander Green's Emergency State-of-the-Market Summit, a free subscription to Liberty Through Wealth, and offers from us and our affiliates that we think might interest you. You can unsubscribe at any time. Privacy Policy.) Good investing, Alex |
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