3 red flags to avoid when investing in microcaps according to Emanuel Datt

April 22, 2024: As a relatively under researched sector of the stock market microcaps offer great  opportunities for outperformance, but they also come with significant risks, according to boutique  Australian equity investment manager, Datt Capital.

“The only way to succeed over time in microcap investing is to take a long-term view and research orientated approach, investing in internal research over many years,” Emanuel Datt, chief investment  officer of Datt Capital said.

“We have found that significant idiosyncratic alpha can be generated in the space by actively working  with management teams to enhance value for all shareholders as well as improving governance and  capital allocation decisions,” he added.

The investible universe of microcaps on public markets outside the S&P/ASX 300 is around 1500  shares but there are at least three definite ‘red flags’ that investors need to consider when looking at  this sector, according to Datt.

“The first red flag is around inappropriate corporate governance practices. Even small companies  should have appropriate independent boards in place as they are essential for compliance and  shareholder protection.

“The second red flag looks at extensive related party transactions. If a company wants to grow and  achieve larger market sizes it needs to develop its own internal capabilities which can grow as the  company grows.

“The third red flag is inadequate management expertise. Management needs to be skilled and hold  relevant experience in the company’s sector.”

Avoiding these red flags and focussing on long term research and relationships with microcap  companies when they are small can reap big rewards, Datt says.

One such stock that has delivered for Datt Capital is exploration company WA1 Resources, which  made a discovery of rare earth element niobium two years ago.  

“We believe an Australian source of supply will be highly sought after by Asian steel industry  customers and be integral to the emergence of the nascent niobium battery technology industry,”

When Datt Capital first invested in WA1 it had a market cap of $90 million but that has now grown to  a market cap of around $1 billion.  

About Datt Capital  

Founded in 2016, Datt Capital is a Melbourne-based Australian focused Long-only Fund Manager.  Datt Capital is focused on generating alpha by structuring its portfolio in a unique and uncorrelated  manner, across asset classes. Its investments consist primarily of listed equity, debt and derivatives  solely in Australian markets.  

Datt Capital's investment approach focuses on finding companies with strategic value where it may  be able to use ‘collaborative activism’ techniques to realise alpha and companies run by focused,  prudent and experienced management teams. 

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