Why Your Stock Is Playing Dead: A View From The Street
from
September/October 2002
by Kenneth Kamen
Getting anyone on Wall Street to pay serious attention to what your
company is up to has become a universal frustration for CEOs and board
members of smaller-cap outfits—particularly when the analysts, brokers,
and other Wall Street professionals seemed so impressed while you were
describing your product or service. After all, isn't everyone looking
for the next big thing?
Obviously, the market correction of the last two years has reduced appetite for risk, and investors are loath to commit funds to the more speculative companies. What is not so apparent is that there have been some very real structural changes in the stock market itself, changes that Wall Street needs time to digest and adapt to before it turns to you. The big three:
1) The advent of electronic communications networks means that investors can trade directly with one another rather than using the services of a market maker. While this has produced the intended benefit of narrowing the spread between the bid and ask on most securities, it has also removed the incentive that brokerage firms need to follow small companies. Without the income derived from making a market in these securities, the short-term risks of championing the cause of a relatively small, illiquid company far outweigh the potential long-term rewards.
2) The compensation structure of the entire brokerage community is another reason small stocks lie lifeless. In today's world of online trading and discounted commissions, it is increasingly difficult for brokers to charge investors the higher fees usually associated with the effort and homework required to follow a comparatively unknown outfit. In addition, many brokers have abandoned small companies altogether, the result of a phenomenon known as trading away. This occurs when a client buys a nominal number of shares through the broker who discovered and recommended them, and then places a far bigger order for the same shares with a discount broker. Traditional brokers don't want to recommend stocks that encourage their clients to move assets elsewhere.
3) Regulation Fair Disclosure, the Securities and Exchange Commission rule that requires companies to provide the same information to everyone rather than informing a select few, has made brokerage support tougher for small corporations to find—it has taken away the reward, in cash and reputation, that brokers collected for knowing a company better than the next guy. The rule has also made it potentially dangerous for Wall Street professionals to really get to know the management of the companies they follow. This is probably Reg FD's greatest flaw. As any experienced investor can tell you, only three things separate the good companies from the great ones: management, management, and management.
So should you give up on your stock? Not at all. Wall Street will figure out how to work profitably with small outfits. It is also apparent that regulators are starting to recognize the need to ensure a vibrant marketplace for small-cap stocks. The squeeze on small companies is being felt in all parts of the country. As every elected official and bureaucrat knows, small business provides more than 90% of the jobs in the U.S. and most of the nation's productivity growth. Be assured that the problem is not going unnoticed. Further, as the massive losses caused by the bursting of the bubble fade into the past, investors will start to come out of hiding.
What to do between now and then? This is the period in the investment cycle when a board's time is probably best spent helping the CEO to build the company's value rather than trying to find Wall Street fans. The buyers will be back. Make sure you have a good story to tell them. Over the long run, the market is still a very efficient pricing mechanism.
Kenneth Kamen is the president of Mercadien Capital LLC.
