What constitutes a quality small cap company?

[Tommy Kristiansen]

Hey, guys! I’m currently setting up a watchlist in Tikr for quality small caps, and I was wondering what you look for in that context?

Numbers won’t capture all signs of quality, obviously, but I’d like to get some input nonetheless.

 

[Edd]

Typical quality factors are:

• High gross margins
• Low volatility in margins
• Revenue and earnings growth
• High and stable ROE and ROIC/ROCE
• Solid balance sheet (low leverage, net cash position etc)
• High cash conversion

In a screener I would also include some valuation metrics to allow for multiple expansion.

More information in this discussion note from NBIM: https://www.nbim.no/en/publications/discussion-notes/2015/the-quality-factor/

[Tommy Kristiansen]

Thanks!

I used the Piotroski F-score as a starting point and added gross margins above 40%, as well as good ROE/ROIC – in correlation with growth. Never actually used the Piotroski before, but I think it serves as a decent guideline. Especially in the context of 2020. It needs to be said that I pre-screen on balance sheets beforehand. Not as conservative as I usually am, but enough to avoid the cyclicals slipping through the Piotroski.

I’ll add on the stability-perspective, as I’ve not taken that into account. Some Nordic companies have found themselves on the prelimiary watchlist, albeit quite expensive on most valuation metrics. Makes a good starting point nonetheless. You never know when shit hits the fan.

Great resource btw! Never thought of looking it up in NBIM.

[Author]

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