A recent survey of Canadian investors by PricewaterhouseCoopers LLP found a healthy appetite for initial public offerings during the first half of 2017. In contrast to the same period last year when there were zero IPOs, the first six months of 2017 saw 16 new issues for a total market value of $2.9-billion. In addition, there appeared to be unsatisfied demand for more new issues that was not matched by companies looking to raise new capital. A possible explanation for this shortfall is the presence of sizable pools of private-equity funds, which provide an alternative route to raise capital.
If your risk profile permits investment in the illiquid and information-deficient sector of private equity, but your broker isn't providing access, then I have a suggestion: Check out the stocks listed on the TSX Venture Exchange. They will likely have a longer track record, better financial disclosure through the System for Electronic Document Analysis and Retrieval (SEDAR) and a board of directors that is familiar with the current thinking on governance. Equally important, you can invest smaller amounts so as to create a diversified portfolio, your transaction costs can be close to $10 a trade and you will have some degree of liquidity if the investment turns sour.
Your immediate reaction is probably that the Venture Exchange is full of illiquid resource stocks that are little more than mining claims or oil exploration long shots, so let's go through the numbers.
Based on the Globe Investor Gold website, the number of Canadian common stocks listed on the Venture Exchange is just more than 1,700. If we remove those with a market capitalization less than $2-million on the grounds that they are even less liquid than private equity, we are left with a new total of just more than 1,000. This is still too many to research with traditional ratio analysis, so let's deduct resource stocks in the mining, precious-metals, forest-products and energy sectors. I am not suggesting that there are no stocks of interest in these industry sectors, just that success or failure with these investments is largely a result of a correct forecast of commodity prices and that is a different skill set.
With resource stocks removed from the Venture Exchange, we are left with about 330 stocks in the remaining industry sectors – more than enough as a starting research universe. There are about 50 each in business services, consumer products, industrial products and other services, with another 30 in financial services and 20 in real estate (the rest of the industry groups were relatively small), so a well-diversified portfolio should be easily achievable.
Many private-equity investments involve companies in the startup phase of their life cycle, which is part of the attraction to an early-stage investor, but it also injects significant risk into the equation. The financial ratios at the time of the fundraising provide little guidance as to the sustainable profitability of the enterprise going forward, especially if the cash influx is intended to roll out a new product range or enter new geographic markets.
To minimize this risk and to shrink the research universe, I screened the remaining 330 stocks to include only those with a five-year history of revenue and that are recently profitable. This left 39 companies with a sustained demand for their product or service and that are probably not bleeding cash. (Both of these assumptions need to be verified: a database of microcap stocks almost certainly contains errors and stale-dated financials.)
As expected, a quick review of this short list turned up several database errors. Paradoxically, I view this as good news for an individual investor: It means that in this sector of the market, there is information inefficiency and a potential payoff for your own basic financial research.
I don't own any of the following six stocks as few of them qualify as value investments, but this sampling illustrates the diversity of products and technology available on the TSX-Venture Exchange if you plan on creating your own "almost private" equity portfolio. (All ticker symbols are Venture Exchange and the online description of the business may not do them justice. Do your homework.)
- Cematrix (CVX): cellular concrete technology used in infrastructure projects;
- Imaflex (IFX): poly film producer with $75-million in revenues;
- Sigma Industries (SSG): composite and metal components for trucks with $55-million in revenues;
- Sportscene Group (SPS.A): franchisor of sports bars with $85-million in revenue;
- Redishred Capital (KUT): operator of the “Proshred” brand with 29 locations in the United States;
- Solar Alliance Energy (SAN): solar installations for residential, commercial and industrial applications.
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.