GLOSSARY OF TERM
Please read the following carefully.
Investment Bonds
A bond is a debt investment in which an investor loans money to an entity (typically corporate or governmental) which borrows the funds for a defined period of time at a variable or fixed interest rate. Bonds are used by companies, municipalities, states and sovereign governments to raise money and finance a variety of projects and activities. Owners of bonds are debtholders, or creditors, of the issuer.
Small Cap Stocks
Small capitalisation stocks are relatively small stocks with market capitalisations of below $100 million. The definition can vary between brokerages and can change from time to time. It is in the field of Small Cap Stocks where large growth potential can often be found, as institutional investors often do not research them and mutual funds often have restrictions prohibiting them from establishing meaningful positions in Small Caps.
Micro Cap Stocks
Micro cap refers to a stock with a market capitalisation of below $50 million, although definitions vary. This sector represents very high risk as the stocks are usually in the earliest stages of development but as a result may offer tremendous long term potential through participating in these types of fledgling investments.
Large Cap Stocks
Large caps are stocks with market capitalisations of between $10 billion and $200 billion, although definitions vary. These are amongst the largest of stocks trading on the markets and can offer excellent dividend income. However, when considering growth on capital, as these are the behemoths of the stock markets it is worth remembering the maxim that “elephants don’t gallop”.
Middle-Market Private Firms
This type of Private Equity financing comprises the provision of growth capital for medium-sized companies. Such companies normally have an established market position, have a good market capitalisation and generate sales of several million US Dollars and are profitable or about to be profitable. Here, Private Equity capital is either used to finance further expansion (e.g. major projects, acquisitions) or to allow a change in ownership structure (e.g. succession arrangements). This is one of Rothwell’s main fields of operation and is a key market for Rothwell’s clients.
Volatility
Volatility describes the degree of fluctuation in the price of a stock. The greater the volatility (the fluctuations), the more risky the stock is considered. Normally, volatility depends on the size of the stock: The smaller the company’s capitalization, the easier the price of the stock can be influenced, i.e. the bigger is the volatility. Small Caps, in other words, are usually considered more volatile investments than large caps.
Liquidity
Liquidity depends on supply and demand. In the limited markets for Small Caps either one can be much bigger than the other resulting in unreasonably rising or falling prices or even the impossibility to find a buyer at all. Liquidity in simple words refers to how easily a share can be bought and sold on the market in relation to the influence on its price. A share is liquid when there are enough shares in circulation to allow large transactions to be made without a substantial change in the price (see volatility). The shares of a Small Cap company might not be liquid or freely tradable, there may be a limited market in the company’s shares on a daily basis, there may be no shares available to buy and sometimes shares cannot be sold because a buyer cannot be found. There might even be a restriction in selling (see Restriction) and an obligation to hold the stock for a defined period of time. Additionally, access to information might be scarce. This is where Rothwell’s expertise is instrumental in filling the information gap.
Transparency
The Small Cap markets can sometimes be poorly regulated and as a result transparency can be low. Key information may be difficult to obtain, or may only be accessible to a specialist such as Rothwell. This can make it difficult to evaluate and monitor investments in small caps, therefore, Private investors in particular, should always consult a reliable professional advisor to be properly informed.
Exit Strategy
One of the keys to successful Small Cap investment is the “exit”, in other words, selling the investment at the right time. To profit from Small Cap investments, investors should look for a clearly defined exit possibility such as a take-over or merger or be prepared to take a long term hold in order for the stock to have sufficient time to mature and go through the anticipated development and growth periods. An exit strategy usually covers a period of between 1 and 5 years. The investor should be prepared to hold the stock for this period of time.
Leverage
The extent to which an investor or a company is using borrowed money. For companies, leverage is measured by the debt-to-equity ratio, which is calculated by dividing the long-term debt by shareholders’ equity. The more long-term debt there is, the greater the financial leverage and the greater the risk of the company failing. For investors, the term means the practice of investing with borrowed money to increase potential profit.
Short Selling
The sale of a stock which the seller does not own. This is a speculative practice done in the belief that the price of a stock is going to fall and the seller will then be able to cover the sale by buying the stock back at a lower price. Any profit would be the difference between the initial selling price and the subsequent purchase price. It is illegal for a seller not to declare a short sale at the time of placing the order.
L.S.E
The London Stock Exchange is a public limited company and is the primary stock exchange in the U.K. and the largest in Europe. The LSE is the most international of all stock exchanges with companies from more than 50 countries being listed. Through its two primary markets – the Main Market and AIM (see AIM) – the LSE gives companies access to one of the world’s deepest and most liquid pools of investment capital.
OFEX
OFEX is a share trading facility run by OFEX Plc. OFEX is authorised and recognised by the U.K. Financial Services Authority (FSA) and it is also recognised as a “prescribed market” under FSA rules. It is not a recognized or designated investment exchange. Companies trading on OFEX are not listed and are not subject to the same level of regulation as those companies trading on the AIM market or those companies with a full listing on the London Stock Exchange. Consequently there is a much higher level of risk attached to companies trading on OFEX. It may be difficult to obtain reliable information about the current trading positions of companies trading on OFEX. Where there is only one market maker quoting prices, there may be occasions where it may be difficult buying or selling shares of companies trading on OFEX. Similarly, there may be a wide difference between the buying and the selling prices (spread) and consequently if you have to sell OFEX shares immediately, you may get back much less than you paid for them. Prices quoted on OFEX may be only indicative and therefore may not be reliable or guaranteed. Furthermore, prices quoted may be historical and may not reflect recent trading. There may have been little or no trading in the stock of a company trading on OFEX since its issue onto the market.
Over the Counter Bulletin Board (OTCBB)
The U.S. equivalent of the UK Alternative Investment Market or AIM, this exchange is now one of the most popular forms of private investments in the USA. The OTCBB generally trades in companies which are not yet large enough to obtain listings on either the AMEX of NYSE.
Offer Price / Ask Price
The price at which stocks or shares are offered for sale, generally higher than the Bid Price (see also Bid Price).
Spread
The spread is the difference between the bid and the offer price. The bid price has to exceed the offer price in order for the investment to be in profit. Therefore, as this incurs in a time factor, it is one of the reasons why stocks should not be viewed as short-term investments.
Knowing Our Clients Rules
In advising our clients for suitable opportunities a profound understanding of the client’s acceptance for performance volatility is critical, as is the expected trade-off between performance and volatility and risk and reward. For those investors using Rothwell’s information services to base their investment decisions, we establish a risk profile for each client based on the standards within the UK.
Regulation S was established by the U.S. Securities and Exchange Commission (“SEC”) in 1990 and was substantially amended in 1997. It was created to make it easier for non-US investors to invest in U.S. public companies. There is usually a one-year “Distribution Compliance Period” restriction from trading the Regulation S shares on U.S. markets for non-U.S. citizens, following the issue date of the security. Investors can sometimes buy REG S securities at a discount from the primary U.S. public market. This discount compensates the buyer for the risks associated with the mandatory one-year restriction from resale of the stock to U.S. investors or through U.S. securities markets.
Small Cap Stocks
Small capitalisation stocks are relatively small stocks with market capitalisations of below $100 million. The definition can vary between brokerages and can change from time to time. It is in the field of Small Cap Stocks where large growth potential can often be found, as institutional investors often do not research them and mutual funds often have restrictions prohibiting them from establishing meaningful positions in Small Caps.
Private Equity
Private Equity is usually defined as investments in privately owned companies that are not listed on the stock market. However, Private Equity can also be private placements of listed companies.
Listed companies often tap the private equity market to fund the development of new products and technologies, increase their working capital, make acquisitions or optimise their capital structure.
Private Equity investments may offer investors the potential of higher returns than the usual stock or bond investments. They offer the seasoned investor a good tool for diversification because they have a relatively weak correlation with the traditional markets and are thus not dependent on market trends. However, the capital invested should normally be viewed on a long term basis, usually 1-5 years or beyond.
Mid Cap Stocks
Mid caps are normally stocks with market capitalisations of between $2 billion to $10 billion, although definitions may vary.
Venture Capital
The term “venture capital” is generally used for quite a widespread method of investing in start-ups. It normally involves providing risk capital for companies that are not yet profitable and are thus unable to raise a bank loan or tap other sources of financing. Therefore, these companies often depend on private investors. A venture capital funding arrangement will often entail relinquishing some level of ownership and control of the business by the current owners. So normally, investors look for more than a mere capital investment.
As a general rule, Rothwell restrains from advising its clients on venture capital investments. Exceptionally, cases with a clear exit strategy such as a defined IPO (Initial Public Offering) might be covered by Rothwell.
Distressed Firms
This involves investing in companies that are in financial difficulties in return for a stake in the company. The perspective is an expected turnaround or the liquidation of undervalued parts of the assets. Investors usually follow a take-over strategy and seek some kind of control. They might have an entrepreneurial interest or just the intention to liquidate parts of the company.
This sector should normally be considered by very seasoned investors only.
Market Capitalisation
The total value of a company’s issued shares, excluding any that have been repurchased by the company. Simply put, this is a comparative measure of the company’s size obtained by multiplying the share price by the number of shares in issue.
Trading Restriction
In Small Cap companies in particular, it is not unusual for a restriction to be applied to the selling of the shares. For example, the share might have to be held for a minimum of a year before it can be sold. Such restrictions may reduce the scope for profiting from a short-term sharp rise in the price of a share. The restriction helps the company by knowing that it has the shareholders investment for a minimum period of time and also benefits loyal shareholders who are investing in the long term potential of the company’s business model and the company itself.
Risk of Bankruptcy
By nature, Small Cap investments have greater exposure to the risk of bankruptcy than larger caps. Companies financed at an early stage in their development when the growth potential is largest carry a higher risk of bankruptcy than larger, well-established corporations.
Long Only
The long only strategy means, no leverage, no derivatives and no short selling. Leverage generally refers to increases in market exposure achieved by direct or indirect borrowing. It therefore increases performance risk and volatility. Rothwell exclusively recommends a long only strategy and strongly advises against any increases of risks for small cap investments.
Derivatives
The most common usage relates to the use of pre-defined contracts relating to the right to buy or sell an underlying security rather than to the security itself i.e. they are “derived” from the security rather than being the security itself.
Benchmark
By benchmark we understand the level to which a specific strategy is compared to.
Example: A long only blue chip investor can compare his performance with the Dow Jones index and see whether his choice was better than the performance of the 30 biggest US stocks.
The evaluation of the historic performance of Small Caps is often hindered by the difficulty of setting an appropriate benchmark. This is important both for the assessment of manager / advisor skill and for risk appraisal.
The Alternative Investment Market (AIM)
Formed in 1995 the Alternative Investment Market is a trading platform for small, young and growing companies from all over the world operated by the London Stock Exchange as a regulated market of a Recognised Investment Exchange. It replaced the Unlisted Securities Market (USM). The market provides an opportunity for companies to raise capital for expansion, a trading facility and a way of establishing a market value for their shares. AIM now lists over 1,000 companies. AIM companies tend to trade on wider spreads than companies on the main market and therefore tend to be less liquid. Companies listed on the UK’s AIM market normally have a market capitalization of under £100 million. AIM is a market designed primarily for emerging or smaller companies. The rules of this market are less demanding than those of the official list of the London Stock Exchange and therefore carry a greater risk than a company with a full LSE listing. One of the advantages of investing in AIM companies for UK tax payers is that for tax purposes any shares bought after 6 April 2000 are treated as ‘unquoted investments’ (even though they are quoted). The significance of this is that for every year that you hold AIM shares, you get 5% ‘taper relief’ on any gains you subsequently make. So if you are a higher rate taxpayer who would normally pay 40% Capital Gains Tax (CGT) and you hold shares for one year then sell them, you only pay 35% CGT. If you hold shares for four years or more, the tax rate falls to 10%. Of course, this system encourages long term investment and support for smaller companies and should be a key consideration for all would-be investors.
NASDAQ (NASD)
The National Association of Securities Dealers is the organisation which owns and operates the US NASDAQ exchange (National Association of Securities Dealers Automated Quotation System). When measured by Market Capitalisation, the NASDAQ is the second largest stock exchange in the world after the New York Stock Exchange (NYSE). However the NASDAQ now lists more companies than the NYSE and the volume of shares traded also exceeds that of the NYSE. The exchange is a computerised system and provides quotes for most U.S. and Canadian Stocks. It is also authorised by the Securities and Investment Board in the U.S. as a “Recognised Investment Exchange” and is the fastest growing major stock market in the world being home to over half of the companies traded on the primary U.S. markets.
Regulation S (REG S)
Regulation S establishes “rules governing offers and sales made outside the U.S. without registration under the Securities Act of 1933”.
Regulation S was established by the U.S. Securities and Exchange Commission (“SEC”) in 1990 and was substantially amended in 1997. It was created to make it easier for non-US investors to invest in U.S. public companies. There is usually a one-year “Distribution Compliance Period” restriction from trading the Regulation S shares on U.S. markets for non-U.S. citizens, following the issue date of the security. Investors can sometimes buy REG S securities at a discount from the primary U.S. public market. This discount compensates the buyer for the risks associated with the mandatory one-year restriction from resale of the stock to U.S. investors or through U.S. securities markets.
Bid Price / Sell Price
The selling price potentially available to the seller or the price at which an institution may buy back the shares. The bid price is lower than the Offer Price (see Offer Price).
Regulation S was established by the U.S. Securities and Exchange Commission (“SEC”) in 1990 and was substantially amended in 1997. It was created to make it easier for non-US investors to invest in U.S. public companies. There is usually a one-year “Distribution Compliance Period” restriction from trading the Regulation S shares on U.S. markets for non-U.S. citizens, following the issue date of the security. Investors can sometimes buy REG S securities at a discount from the primary U.S. public market. This discount compensates the buyer for the risks associated with the mandatory one-year restriction from resale of the stock to U.S. investors or through U.S. securities markets.