Investing in micro and small cap stocks offer investors unique opportunities. In fact, during the recent market rally from March 2009 until present, small cap stocks have largely outperformed mid and micro cap stocks. While investment into these stocks can be risky, the rewards can be fruitful as well.

Spending time to analyze these companies is the key to success. Evaluation of company fundamentals plays a crucial role in the future price of company shares. Some basic questions that you can ask yourself about a company are as follows:

What are the company’s strategic goals?
For example, if a company sells light bulbs, what specifically are they doing to increase future sales? Do they have a marketing plan in place? Are they developing new and more efficient forms of the product? Do they have contracts with retailers to sell their products?

Is the company adequately capitalized?
A company may have the greatest idea in the world. However, without the proper capital to move forward, the idea is bound to fail. Undercapitalized companies will miss out on important opportunities for growth potential and eventually fail from the lack of working capital. Reviewing the company’s balance sheet and cash flow statements will reveal this fact. Look specifically at free cash flow and cash from operating activities located on the cash flow statement. Increasing year-over-year numbers will represent solid growth potential and decrease the possibility of insolvency in the near future.

Is the company loaded with debt or liabilities?
The balance sheet will reveal the debt and liabilities of the company. A firm that is loaded with either of these is at risk. Short-term debt and accounts payable will drain capital from the company and put it at risk of being unable to gain future lines of credit.

Who is leading the company?
The success or failure of a firm can ultimately come down to who is leading it. Inexperienced or misplaced management teams generally lack the ability to lead a firm properly. Spend time to do research on the management team. A manager who has a track record of previous industry experience and success is a much better candidate than someone without either of the credentials. Go ahead, call the company directly and tell them you’re a prospective investor. Chat with executives. In many cases, the CEO’s of micro and small cap companies may be surprisingly accessible.

What industry is the firm competing in?
Selling toilet paper to grocery stores is not a new idea and offers limited growth potential. Growth sectors that are new and untapped present the best investment opportunities. Companies that are paving a new path with new technology are exciting and can build investor confidence. While this certainly does not guarantee success, it is a good place to start.

Would you buy the product or service?
Ask yourself honestly. If the firm fails to excite you on what they’re selling, how are they going to find other buyers?

Skin in the game?
What this means is do executives have their own capital at risk? A management team that has a personal investment in the firm has a lot more on the line and is likely to work that much harder to be successful.

Location, location, location.
While the saying applies to real estate, we can also apply it to companies doing business in foreign markets/regions of the world. Clearly, companies looking to drill for oil in Venezuela or sell cars to the Nigerian government face a certain amount of geopolitical risk. These can be warning signs and the risk should be properly analyzed.

Barriers to entry.
How difficult was it for the firm to get up and running in their specific industry? Will it be easy for competitors to jump on board and dilute market share? A good middle ground is important. You don’t want it to be too easy to enter the market, yet it shouldn’t be so hard that the firm is at risk of failing itself. There are many credited government web sites where important forms such as 10Ks, 8K, and other SEC filings can be found. Not only are these important to the transparency of the firm but they can also offer good information not available on a balance sheet or in a stock price.

The best way to get the answers to your questions may not be available on the internet! So how can you get answers? Typically, these companies are small enough that a call to their offices will get your through to management. You won't be the first or last investor calling for information. We recommend this strategy as you can get a real feel for the company and the people leading it.