Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 202

Corporate activity helps build a small cap portfolio

A common theme of investing in small cap stocks is limited liquidity, or in other words, difficulty acquiring or selling stock. This can naturally present a challenge for those on the outside looking in (and even those on the inside looking out). Investors can be left scratching their heads as to how an equity fund manager has built a significant stake in a particular stock given its limited trading volume.

This article outlines the corporate opportunities presented to fund managers and some key points for retail investors to position their portfolios towards higher quality small-cap stocks and management teams.

Rights issues

Rights issues allow companies to raise funds without penalising existing shareholders. Raisings are typically done at a decent discount where existing shareholders are invited to purchase additional shares in the company. For small caps, rights issues are usually non-renounceable, that is not tradeable, which means liquidity might not improve as the rights are tied only to existing shareholders. However, any underwriting of a rights issue shortfall provides a way for new shareholders to access shares which is effectively a placement of rights which are not taken up by existing shareholders.

Key point: watch for management and substantial shareholder involvement. If they are not prepared to take up their rights in full, then consider, why should you? Is the offer accelerated or not? If not it can have a drag on the share price.

Placements

Placements are the bread and butter of growth capital in small caps, often providing the most effective entry point for a fund manager to gain meaningful positions. Placements may be done in conjunction with a share purchase plan (SPP) which provides all existing shareholders the ability to subscribe for up to $15,000 worth of stock under the same terms as those participating in the placement. We like it when companies offer an SPP as it shows they are treating all shareholders equally.

Key point: for a retail shareholder when deciding whether to participate in an SPP, consider these two red flags; firstly, is the placement only for working capital purposes? Secondly, is the placement occurring at a price lower than a previous placement?

Private placements

A private placement is when a company conducts a share transfer to one particular shareholder. Typically, this will occur either to a strategic investor or to a fund manager who is unable to buy the desired share parcel on the market. Private placements are encouraging for investors and they shows that someone is willing to be the only party providing growth capital and are therefore likely to be a long-term investor.

Key point: is the placement a transfer of existing shares from a large shareholder or new equity raised? We prefer seeing new equity private placements as it shows key shareholders are not cashing out and it provides the company with growth capital.

Sell-downs

As a rule of thumb, if directors or management are selling, external investors should not want to buy. There are however exceptions where it can prove to be a highly effective way of improving liquidity, attracting institutional investors and improving the business profile within the market.

A sell-down should be judged on a case by case basis, and questions to ask include:

  • Who is selling down, why and how much?
  • What is the cash balance of the company?
  • Is this the best way to improve liquidity?
  • Are they likely to require a capital raising short term?

We like to see a strong management track record or share price returns and organic growth before we consider participating in a sell down.

Key point: be sceptical where you see a manager sell-down to exit their full position, as skin in the game is paramount for quality small caps.

IPOs

Investors can be right to ignore a small cap IPO, as the business can be ‘dressed up’ for sale and a prospectus can only tell you so much. You are unlikely to get a good read on how successful management has been on actuals vs forecasts in the past, and this can create a high level of downside risk.

Unlike a private placement or sell-down, IPOs tend to be more widely spread to participating investors. This means fewer ‘long-term hands’ and more ‘short-term hands’ will receive stock. Furthermore, a lot of the time you are either paying down debt or funding an individual cashing out. In any good quality small cap, you don’t particularly want to be funding either of those.

Key point: take a long-term view. Would you be happy to own shares in this business for three years or are you just banking on a short-term trade? If the latter then you’re probably not the only one and the optimism might not translate to reality.

Advice for retail investors

You can learn a lot from the actions of a company’s board, management, and key shareholders. How they conduct their corporate activity can give you confidence or otherwise in their long-term thinking. A healthy amount of scepticism can prove a valuable commodity when picking stocks.

 

Robert Miller is a Portfolio Manager at NAOS Asset Management. This article is general information, it is not intended as financial advice and does not consider the circumstances or investment needs of any individual.


 

Leave a Comment:

RELATED ARTICLES

Is now the time to invest in small caps?

Small caps are compelling but not for the reasons you might think...

Hold fire on your fund manager over short-term declines

banner

Most viewed in recent weeks

Raising the GST to 15%

Treasurer Jim Chalmers aims to tackle tax reform but faces challenges. Previous reviews struggled due to political sensitivities, highlighting the need for comprehensive and politically feasible change.

7 examples of how the new super tax will be calculated

You've no doubt heard about Division 296. These case studies show what people at various levels above the $3 million threshold might need to pay the ATO, with examples ranging from under $500 to more than $35,000.

The revolt against Baby Boomer wealth

The $3m super tax could be put down to the Government needing money and the wealthy being easy targets. It’s deeper than that though and this looks at the factors behind the policy and why more taxes on the wealthy are coming.

Are franking credits hurting Australia’s economy?

Business investment and per capita GDP have languished over the past decade and the Labor Government is conducting inquiries to find out why. Franking credits should be part of the debate about our stalling economy.

Here's what should replace the $3 million super tax

With Div. 296 looming, is there a smarter way to tax superannuation? This proposes a fairer, income-linked alternative that respects compounding, ensures predictability, and avoids taxing unrealised capital gains. 

The rubbery numbers behind super tax concessions

In selling the super tax, Labor has repeated Treasury claims of there being $50 billion in super tax concessions annually, mostly flowing to high-income earners. This figure is vastly overstated.

Latest Updates

Investment strategies

Trump's US dollar assault is fuelling CBA's rise

Australian-based investors have been perplexed by the steep rise in CBA's share price But it's becoming clear that US funds are buying into our largest bank as a hedge against potential QE and further falls in the US dollar.

Investment strategies

With markets near record highs, here's what you should do with your portfolio

Markets have weathered geopolitical turmoil, hitting near record highs. Investors face tough decisions on valuations, asset concentration, and strategic portfolio rebalancing for risk control and future returns.

Property

Soaring house prices may be locking people into marriages

Soaring house prices are deepening Australia's cost of living crisis - and possibly distorting marriage decisions. New research links unexpected price changes to whether couples separate or silently struggle together.

Investment strategies

Google is facing 'the innovator's dilemma'

Artificial intelligence is forcing Google to rethink search - and its future. As usage shifts and rivals close in, will it adapt in time, or become a cautionary tale of disrupted disruptors?

Investment strategies

Study supports what many suspected about passive investing

The surge in passive investing doesn’t just mirror the market—it shapes it, often amplifying the rise of the largest firms and creating new risks and opportunities. For investors, understanding these effects is essential.

Property

Should we dump stamp duties for land taxes?

Economists have long flagged the idea of swapping property taxes for land taxes for fairness and equity reasons. This looks at why what seems fairer may not deliver the outcomes that we expect.

Investing

Being human means being a bad investor

Many of the behaviours that have made humans such a successful species also make it difficult for us to be good, long-term investors. The key to better decision making is to understand what makes us human and adapt.

Sponsors

Alliances

© 2025 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.