If You Want to Make Money in Small-Cap Stocks… Throw Out the Playbook

I enjoy reading investment books.

From Peter Lynch’s One Up on Wall Street to The Intelligent Investor by Benjamin Graham, we all have our favorites. I particularly like Buffett: The Making of an American Capitalist and A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing.

I consider these books required reading for new and experienced investors.

But what I am about to tell you will blow your mind. If you want to make money in small-cap stocks you absolutely must throw away every investment book you ever read.

These books might make you a better investor. But they won’t make you any money investing in small-cap stocks.

Let me explain…

In One Up on Wall Street, Peter Lynch wrote, “Earnings drive stock prices.”

But in the universe of small-cap stocks many companies don’t have earnings. Most of the money they generate goes right back into the business. This makes sense since you need to spend money to grow your business. That’s how small-cap companies become large-cap industry leaders.  

In fact, you would have never bought companies like Amazon (AMZN) in 1997, Tesla (TSLA) in 2010, and Netflix (NFLX) in 2009. These industry leaders were small-caps back then. And they didn’t generate any profits.

Amazon is up 51,000% since 1997… Tesla is up 1,300% and Netflix is up 3,700%. If you followed Peter Lynch’s advice, you would have never had the chance to generate these types of life-changing gains.

In the Intelligent Investor, Benjamin Graham says to invest in companies with solid balance sheets that have paid uninterrupted dividends for at least 20 years.

Following Graham’s advice, you would have steered clear of just about every small-cap stock listed in the Russell 2000 index. After all, most small companies do not pay dividends. Like I mentioned earlier, most of their cash is reinvested (technology, acquisitions, hiring the best talent) to grow their business.

If you followed Graham’s advice you would have never invested in Microsoft (MSFT), Amgen (AMGN), or Apple (AAPL) when they were small-caps. These now industry giants were not paying dividends in their early growth phases.   

And you would have steered clear of just about every small-cap stock during the credit crisis since most balance sheets were shot to hell. That’s a shame since the Russell 2000 small-cap index is up over 300% from the credit crisis March 2009 low.  

Warren Buffett says to buy companies with positive operating income for at least the past seven years.

But some small-cap stocks including social media giant LinkedIn (LNKD) and customer relationship management leader Workday (WDAY)… were not even publicly traded companies seven years ago.

LinkedIn, with a market-cap of $400 billion at the time of its IPO, was purchased by Microsoft in 2016 for $26 billion… Workday, with a market-cap of $600 million at the time of its IPO, has a market-cap of more than $20 billion today.

You would have missed these huge gains if you followed Warren Buffet’s advice.

I could go on, but you get the point: If you followed the rules of investing from the pros mentioned above, you would have never bought any of these stocks. If we followed these rules in Curzio Research Advisory, we’d be just another small-cap newsletter with a terrible track record.

Now here comes the good part…

5 Rules To Successful Small-Cap Investing

As you may not of known by now, I’ve been researching and recommending small-cap stocks and junior miners for over 20 years.

For over that time I’ve become friends with and interviewed some of the world’s greatest resource investors.

I’m talking about guys like Rick Rule, who runs one of the most successful resource-based funds in the world. Guys like Jim Rogers, who made billions riding the commodity boom back in the 1970’s. And guys like Jeff Phillips, who has more 1,000% winners in the junior miner space than anyone else I know.

After all these years I realized they all have one thing in common that I believe is the key to their success…

It’s the stuff the book I mentioned above don’t talk about.

They all follow the same system when it comes to investing in resource stocks.

What is this system?

Well, it really comes down to 5 simple rules for analyzing any small-cap resource investment. If you follow all these rules … you’ll not only reduce your risk in this very volatile sector …

But you’ll find the types of companies that could hand you 100% … 500% … even 1,000% or more in gains … no matter what happens to the price of gold!

So what are those 5 rules?

Let’s start with,

Rule #1: Make sure the company has an experienced management team.

Of all the factors that help determine the success of a small mining company … management may be the most important.

But keep in mind, you have to look for a certain type of experience.

You want to find a management team that has proven it can take a project from discovery to actual production.

The fact is … only one out of every 3,000 mines ever makes it from early stage to actual production.

Those are very bad odds …

But when you look deeper there are certain teams that have long histories of bucking this trend … and consistently creating profitable mines.

That’s why finding an experienced management team is one of the first things I look for when analyzing junior miners.

Rule #2: Show me the Money.

On the flipside, the mining industry is one of the most capital intensive businesses in the world.

Taking a small junior resource company from discovery to production requires millions of dollars in upfront investment before investors ever see a dime of revenue in return.

If a company doesn’t have the capital to hold it over for at least 18 to 24 months … they are dead in the water.

Which means they might resort to tactics like issuing more shares or warrants which probably will result in falling share prices.

That’s why you want to make sure you invest in companies that are always well-funded.

Rule #3: Make sure you can get the resources out of the ground.

It doesn’t matter how many potential ounces of gold your company controls if you can’t get it out of the ground cost effectively …

And two of the most important aspects to control these costs are geography and infrastructure.

It goes without saying that many potential profitable mines are located in countries that could be considered unstable.

I remember a company a few years back called Crystallex that was sitting on over 16 million ounces of gold in Venezuela … to put that into perspective, a 2-million ounce deposit is considered a major find.

The stock price soared up to $6 a share … that is until Venezuelan president Hugo Chavez nationalized the mining industry. Crystallex lost all its assets and shareholders lost all their money.

So you always want to make sure that a company’s assets are located in a stable political region.

Rule #4: Really, make sure you can get the resources out of the ground.

On the flipside, even if the resources are located in a politically stable country … that doesn’t mean the infrastructure will be in place to extract the resources.

You need roads to deliver equipment … you need electricity to run the equipment …

If you have a mine in the middle of nowhere … it could costs millions to build this infrastructure.

That’s millions of dollars that could be spent acquiring more assets.

You want to make sure the company has enough money to cover these costs and still profitably extract the resources.

Rule #5: Put your money where your mouth is.

Here’s the thing.

There’s a lot of big promoters in this industry that will tell you how sweet their deal is … only to go bankrupt in a few months.

But I’ve found the easiest way to distinguish the truly promising companies from the fly-by-night operators is to look at insider ownership.

If management and other insiders own shares of the company … they will be motivated to make it succeed.

And when you put these 5 rules together … you have a good shot at making money in the junior resource market no matter where the price of gold is headed.

Good investing,

Frank Curzio

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