What do nano-cap stocks signal to investors?
Forgive me if this is rudimentary— I don’t work in the public equity space.
Every once in awhile, searching for investments for my PA, I come across a nano-cap. But nearly every time, I’m a little baffled on why this nano-cap is public in the first place. I understand the litany of potential reasons a company might go public— namely, for financing purposes and providing liquidity to insiders (also understanding that going public these days, notwithstanding the somewhat recent boom in IPOs, is becoming less common and companies are staying private longer and longer)— but looking at the number of sketch stocks with questionable business models and given rampant fraud in the market space, I don’t quite understand why investors would entertain this (I get that not all public companies don’t necessarily “IPO”). Nor do I see why sensible management teams would go this route. I’m mostly talking about functioning businesses; I get why near-bankrtupt company may have its equity value dwindle enough to join the nano party.
So my questions are: how should an investor look at nano-caps? How often do little $30m market cap companies actually make it to small cap+ range? How many of these are straight up frauds? Is it even worth looking in this area? Looking at this from a 1 year+ time horizon, not actively trading.
To provide a couple of examples I’ve come across:
- One was selling cloth diapers. The founder/CEO had the prestigious background of being an accounts receivable clerk, and the website was rife with spelling and grammatical errors. If I remember correctly, I’m not even sure revenue reached the 7 figure range. The stock popped (then subsequently crashed again) after a huge reverse stock split and when the company announced it would start making covid masks.
- Another company was pre-revenue, looking to advertise in Ubers and taxis. I get an early stage VC investing in a pre-rev concept, but for this company to have an 8-digit valuation before making a single sale? Why go public instead of search for VC money? A further look revealed some more sketchy financials: the company was partially capitalized by a number of insider loans, most notably from the CEO’s wife. Plus, the “headquarters” address just happened to share the same address as a WeWork. Of course, this stock jumped from about $2 a share to $8 a couple weeks after I looked at it. It hit $20 before settling around $10.
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