How to bet on small businesses positioned to compete

By Rodney DrinnonManaging Partner, McCathern Houston

When people watch any type of competition, they are often inclined to bet on whichever appears to be the biggest and strongest. This is true whether in a courtroom, a boxing ring or the stock exchange. It’s no wonder then that, like The Motley Fool reported“When most investors begin their search for a new stock, it begins and ends with a large-cap name valued at over $10 billion.”

But in all of these arenas, the smallest player (or proverbial “little guy”) can pack the biggest punch. On Wall Street, small caps can offer bigger rewards, to go past their great rivals. The problem is that, like the New York Times Put the“Small-cap value stocks rank among the riskiest stocks in the market.”

How can you know which small cap companies to bet on, especially when they face much larger competitors in their same industry? Through years of experience, I’ve learned what to look for.

I’ve built a career betting on the little guy – and, often, being one myself. As a litigator, I frequently represent small businesses (and take on cases that revolve around investments). I am also a boxer and I represent other boxers. In the ring, my clients and I often face larger rivals. The lessons I learned in both spaces are the same. Small businesses, just like small fighters, can punch above their weight.

When choosing which ones to bet on, look for companies that have these attributes going for them.

Exceptional Preparation

When small businesses compete with industry leaders, they can have a significant intrinsic advantage: being undervalued. For example, like McKinsey wrotelarge, established companies are sometimes “so focused on their traditional competitors that they don’t even recognize the threat posed by low-cost rivals”.

Of course, small caps don’t have to be low cost to give their larger rivals a hard time. The key is for the smaller player to be better prepared than their competition, regardless of size. For example, small business leaders need to know how to take advantage of untapped spaces they can discover in the market. They need to know how to quickly jump on any mistake made by their biggest competitor, like a marketing mishap, for example. They should study what the big companies have done to try to avoid smaller competitors and develop strategies to respond to every possible move.

I follow the adage, “Good preparation prevents poor performance.” In court or in a boxing ring, my clients and I need to be prepared for every eventuality we can think of. In conversations with executives and investor relations representatives, as well as on earnings calls, ask small cap executives what they expect from their biggest rivals and whether they have any strategies to respond to them.

Intrepidity

Bullying is a destroyer. Leaders of a small business must be brave to face a juggernaut. “Don’t be intimidated by the giants in your market,” an Entrepreneur column Put the (next to an image of a small figure in boxing gloves having apparently knocked out a giant). It’s harder than it looks. It’s natural to feel intimidated when your opponent is much taller. This can cause stress, which alters your mentality and takes you away from your game.

Strong small business leaders are people who are absolutely confident that they can win any market, increase their market share, and beat the competition every step of the way. They know size doesn’t matter because anyone can have the smartest strategy and win. Take a close look at the small cap leaders and try to find out if they are really confident or just blustering.

Long term patience

Success takes time. I got hit with a straight right hand in the ring multiple times, to finally to earn on points or a TKO. I had years of dragging court cases where I was up against a much bigger and more expensive team of lawyers on the other side, but we won in the end.

Strong Leaders of a Smaller Competitor want to to win every trick, but won’t be discouraged if he loses one. They will be realistic in their projections of how fast their businesses will grow – balancing hope with a legitimate look at the numbers. They also won’t show any signs of being erratic, suddenly changing their strategy all the time. They will continue to move forward with patience and determination.

When you find a small cap that has all of these characteristics, investing in them is a smart bet. Of course, there are no guarantees – like everyone else, I’ve lost a few cases and a few fights. But I won more. If you look at companies with that kind of discerning eye, you will too.

Rodney Drinnon is co-manager of McCathern Houston.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Comments are closed.