Business – writing sample from “Micro Cap Review”
Entrex Study Confirms That Investor Sentiment Drives Stock Prices,
Even While Revenue Remains Healthy
Finance Expert Stephen H. Watkins Explains How The Innovative TIGRCub™ Can Open Up Capital Markets
CHICAGO — A recent study by Entrex, a Chicago-based company that tracks the performance of micro-cap and private North American companies, confirms what financial experts have long known – that investor sentiment drives stock prices more than anything else.
The Entrex Micro-Cap Review Index (EMRI) further showed that while revenue grew at most companies over the past 10 years, stock prices lagged or fell sharply, further evidence that stock prices aren’t an accurate reflection of a company’s performance.
The conclusion of the EMRI study, released in mid-March, is especially significant today as the stock market continues to make investors hesitant, said Entrex CEO and Founder Stephen H. Watkins, who conducted the analysis. Today’s sliding stock prices on many micro-cap companies do not truly reflect the health of the companies, yet many investors think they do and are fleeing the market.
The analysis, illustrated in the graph below, showed that after Sept. 11, 2001, stocks were slightly down, but only for about a year. Then they rallied until 2003, remaining fairly consistent until 2007. “Consistency doesn’t grow value, though, it just maintains the status quo,” said Watkins, “And everyone knows how stocks have tanked from 2007 on.”
Looking back on the values on revenue stream vs. stock price of 50 top compliant public micro-cap companies ($5 million and $250 million) from 1999 to 2009, shows the revenue performance of a significant number of companies reporting a moderate steady climb, while their respective equity values have either been volatile or have plummeted.
The study pointed out what an average $1,000 stock investment in a top 50 micro-cap company would have garnered investors over the 10 years vs. what the same $1,000 would have earned if it had been based on revenue. The study group included companies like
For example, said Watkins, if an investor put $1,000 in stock in a company in 1999, today, it would be worth about $700. However, he said, that same $1,000 investment based on revenue today, would be worth about $1,700.
Not a bad proposition based on revenue, said Watkins. Yet, since most investments are based on equity value, investors are avoiding the stock market. Which is further creating confusion and chaos in the economy.
“That’s because equity values or share prices of publicly held companies are subject to a broad set of other influencing factors,” said Watkins, “Many outside a company’s direct or indirect control. Ultimately, stock values are drive by investor sentiment, which is what we’re seeing today in the way consumer confidence is affecting the market and keeping it a continuous low.”
At the same time that investors are hesitant to put money in the market, thriving companies and their investment bankers are struggling to raise capital, according to Watkins.
This seesaw effect is presenting new challenges to think creatively, he said, and companies are wise to consider new ways to raise capital. Investors are also seeking innovative investment tools for their clients, who are shunning stocks.
“Eighty percent of companies in the public market are either undervalued or thinly traded,” he said. “They’re the ones who should consider a new solution.” Others, he said, are facing a mound of debt that is coming due, and will get overwhelmed if they don’t do something quickly.
The EMRI isn’t the only proof that revenue has little correlation to stock prices for most companies. Watkins’ Entrex, which researches, tracks, manages and trades interests in companies, also analyzed the performance of >>250?<< private companies over the past few years. The Entrex Private Company Index (PCI) has shown that private companies are beating the downward trend in a tough economy, and growing. It, too, also shows a serious need for capital.
But, Watkins says, “With most investment tools today based on equity in a company, and equity being a bleak proposition right now, what’s a company and an investor to do?”
A Revenue-Based Investment: The TIGRCub™
Last fall, Watkins’ Entrex unveiled a new type of investment tool. To meet the need for investment bankers to have new ways to invest, and to give companies a tool to raise capital, Watkins launched Top-line Income Generation Rights Certificates, or TIGRCubs™. This security structure allows an investor to own a portion of a company’s revenues for a finite period of time, rather than owning equity, as is the case of stock issuances.
Based on revenue and not equity, TIGRcub™ security structures are applicable for both private and public companies and solve a range of corporate finance problems, especially in challenging conditions like today’s traditional capital markets, said Watkins. TIGRCubs™ allows investors to take advantage of a good revenue position or many companies today.
TIGRCubs™ offer investors and issuers an alternative security structure that derives investor returns from top-line revenues. This security grants the investor the right to a monthly fixed percentage of the issuer’s top-line gross revenues for a lump sum capital. What’s more, said Watkins, TIGRCubs™ don’t require a change in corporate governance.
One early firm to take advantage of this new investment tool is fund management firm Arctaris Capital Partners in Waltham, Mass. “The financial markets are at a juncture where the need for innovation of pratical and transparent financial structures are crucial,” said “The time is now for the art of finance to render new solutions that satisfy both investors and companies.”
Arctaris is offering TIGRCubs™ as a solution to bring their investment strategies and portfolios into the next generation of investments. They are licensing the innovative security structure, released in mid-2008, and feel that it promises to revolutionize the way companies and investors view capital.
“Just as markets for other critical resources are changing and adapting to economic conditions today, so should capital markets,” said Watkins. “TIGRCubs™ is leading the way.”
Here is how TIGRCubs™ work:
TIGRCubs™ gives investors five different ways to invest in a company and benefit from its revenue, depending on the investor’s risk style, and needs and wants for cash on cash returns.
- 10-year – Standard TIGRCubs™
- Treasury Guaranteed
- Line of Credit
The TIGRCubs™ can be structured as equity or debt substitutes, according to Watkins, with corresponding risk/return profiles. They can be presented or described in issuance documentation, and reflected in the company’s pro forma financial statements.
For example, a company could issue TIGRCubs™ based on its $50 million in revenue. On a $5 million TIGRCub™ invested capital, the month remittance of 1 to 2.5 percent could be received on a 10-year term.
Watkins said that revenue-based investing is really the stimulus package that the U.S. and global capital markets need.
“A movement away from the customary asset allocations of stocks, bonds, and cash is possible with the proliferation and availability of revenue-based securities. A movement towards asset allocations with revenue-based securities offers a new dimension of investment opportunity,” said Watkins.
According to Watkins, today’s U.S. stock exchanges represent a vibrant and dynamic market where stock trades occur with rapid speed and investors and their agents are constantly buying or selling stocks. This kind of continual and expansive trading creates waves of activity trends in the value of stocks across companies and sectors.
Most investors understand that the price, or value, of a stock rises in the open marketplace because it is in demand and people want to buy it. Conversely, a stock value will decline when there are motivated sellers and fewer buyers, or a decrease in demand for that stock. The reasons for buying or selling however are often unrelated to company fundamentals.
The widespread issuance of revenue-based securities will invigorate both the U.S. and global financial markets with new and attractive investor opportunities, according to Watkins, while at the same time, empower growth oriented micro-cap companies that contribute substantially to the productivity of world economies.
Entrex’s investment banker network of more than 20 banks can help companies make the transition to a revenue-based investment system. Investment firms such Arctaris are helping more companies not only survive, but expand, through TIGRCubs™. “The Entrex Investment Banking network consists of bankers who are well schooled in security products, and are putting together deals every day,” said Watkins.
TIGRCubs™ are better than traditional stocks in today’s market, said Watkins, because stock values of a given company are ultimately subject to investor sentiment, or the beliefs that investors form around a given company stock. Subsequently, he said, they act because of this belief, to buy, sell, sell short, or hold.
Understanding this basic principle of the factors that affect stocks will help companies grasp what is happening today in the sinking stock market, according to Watkins.
Because TIGRCubs are based on company revenues, they are subject to more fundamental market forces such as rates of new customer acquisition and customer loss, customer satisfaction, customer demand, and the ability of the company to deliver goods or services. These are revenue factors.
“Not only are these revenue factors more fundamental to the business of the company but they are also far more transparent than the factors affecting share price,” he said.
Price movement of equity securities happens for reasons that are often difficult to always explain and can happen for reasons that seem unrelated to the business of the company. “Is it surprising then that the market value of public equities has far greater volatility than company revenues?” Watkins asks.
One downside to public equity investments is the share price volatility or “market risk” that can be experienced on a given day, according to Watkins. While, for a number of reasons, the aggregate value of equities has historically increased, there have been wide swings in overall stock values over the long term—recently as much as 10 percent on a given day, he said.
He continues: “The paradox, however, is the difficultly in associating a change in the value of a company’s stock with the factors that actually affected it, unless there was certain adverse news about a company that became available on that day. The source of the change in value is often more related to market factors than the fundamentals of the company.”
“Stock values and markets are essentially sentiment driven, meaning that market factors have an effect on the perceived value of any given stock at any given time,” said Watkins. “When this perceived value is used to buy, sell, or sell a stock short, the closing share price on that day then becomes the actual value of the equity in the marketplace.”
A company’s business position and financials often don’t have a great influence in establishing stock price, according to Watkins. “Watch investors. Within 30 to 60 minutes of watching the activity of the equity capital markets, they can observe tremendous volatility.”
“All the while, if you looked at the businesses underlying those stock values, you typically would not see significant changes in corporate financials or fundamentals that warrant pricing volatility. As a result, an equity value becomes opaque and the fundamentals of the company loose transparency.”
Other non-fundamental factors, such as a research analyst report issued on a company, can affect share price. Or, as another example, redemption timing (i.e. investors redeeming to get cash for their investments), could have a negative effect on the stock values of a given company despite their fundamentals and business outlook—if a large number are requested in a short amount of time.
Ultimately, investors should understand that there is no central, controlling set of factors to predict stock price movement. In the end, equity investment requires high-risk tolerance, game theory intelligence, and constant monitoring to succeed.
A TIGRCub™ requires much less risk, and a lot more pay off.
“In light of the adverse conditions of the credit markets and the challenges associated with raising capital in current public equity markets, TIGRcubs™ offer tremendous benefits to both investors and company issuers,” said Watkins. “The EMRI illustrates my conclusion that investment in revenues can outperform investment in public equity securities. I suspect we’ll find this is especially true under periods of inflation and the mounting pressure on bottom line earnings seen today.”
Watkins sums it up best: “If you’re looking for capital for your client, and who isn’t today, and are open to innovative new ideas, consider TIGRCubs™.”
Stephen Watkins is CEO and founder of Entrex. An entrepreneur, he founded and exited three companies and is the author of Capital Can’t Fund What it Can’t Find. Entrex is the underlying management platform of an emerging capital market that brings investors and issuers together through the TigerCubs™ security, a revenue-based security that represents new financial solutions to a wide variety of corporate finance problems. He lives in Florida.