Ownership Issues
When studying small companies, it can be good to check how much of them is owned by insiders or institutions. It’s generally good if insiders own many shares. After all, if employees own a chunk of a company, their interests are aligned with those of shareholders, and they have an incentive to help it succeed. Insiders buying shares is also promising, as it suggests that they expect the shares to rise in value. Insider sales may seem like bad news, but they may not be. Many executives get a significant portion of their compensation in the form of stock, so they may occasionally sell some shares to generate funds. Many executives selling many shares might be a red flag, though. Meanwhile, it’s good to find promising small companies with little ownership by institutions such as mutual funds and pension funds. Big players are often unable to buy many shares of small companies, giving us smaller investors a chance to get in before they do. Small companies typically have relatively few shares outstanding, and their total value is modest. Imagine, for example, Drive-Thru Dentistry Inc. (ticker: DRILZ), with just 10 million shares outstanding, valued at $20 each. (Total market value: $200 million.) Institutions that might typically buy $20 million worth of a company’s shares can’t do so with Drive-Thru Dentistry without buying fully 10 percent of the entire company, something they’re often prohibited from doing. As a company grows bigger and institutions start buying, their demand can push share prices up, benefiting existing shareholders. Discovering a small but growing company with significant insider ownership and low institutional ownership is a promising scenario. Study the company from many angles before buying, though. Make sure it has growing sales and earnings and a strong competitive position, among other things. You can call any public company and ask its investor relations department about insider and institutional ownership. Or look them up online, at sites such as finance.yahoo.com. Remember, too, that small companies can be volatile. Beginning investors might tread with caution or get more experience first.