Micro cap stocks are those typically defined at around $300 million in market cap or less. Companies of this size are often duds, but, others are super high growth with the potential to fulfill Peter Lynch’s thoughts on small companies…
Big companies have small moves, small companies have big moves…
Peter Lynch from One Up On Wall Street
Microcap Warning
Microcap growth stocks are highly volatile. Short attacks are frequent. Timelines are often missed. Goals are often missed. You must be able to properly tolerate the high volatility that these stocks can experience. If highly volatile stocks that can get whipped around by traders keep you up at night, then none of these are for you.
From Microcap To Smallcap: Russell 2000 Inclusion
Each spring the Russell 2000 engages in a process for adding new companies to the index and removing others. The inclusion is based on market cap. The largest 2000 companies on American markets are eligible.
To reduce index churn, Russell puts a band around the market cap level required for inclusion that allows companies that are on the index, to stay on despite a near miss on market cap, and companies that barely jump the hurdle are kept off.
In 2023 there were 296 companies added to the Russell 2000. The smallest company included had a market cap of $167 million.
The Russell 2000 is up about 10% in the past year, implying that the hurdle market cap for Russell inclusion will be about $184 million this year. The final market cap level could be a bit higher or lower depending on market performance through June 30 which is the final rebalancing.
The first “snapshot” for the Russell inclusion is on April 30. The market is informed on May 24 what the initial results for inclusion are. There are updates weekly through June 28. The rebalance is then done the final week of June and completed by June 30.
Forced Buying By Index Funds
Inclusion into the Russell 2000 ETFs results in forced institutional buying The biggest buyers are index ETFs and mutual funds led by the iShares Russell 2000 ETF (IWM) which is by far the biggest around $58 billion.
Originally analyzed in 2013 in an NBER working paper titled “Regression Discontinuity and the Price Effects of Stock Market Indexing,” Russell 2000 Index inclusion has been observed to correspond to an increase in share price.
The supposition is that index fund buying increased the demand for shares while supply remained relatively constant. Simple supply and demand dynamics. Nasdaq noted last year that trading in Russell 2000 stocks was more than $100 billion during the 2023 rebalancing.
It has also been observed the activity generated by forced index buying has been followed by increased investor interest after the rebalance. The supposition is that traders and investors gravitate to the volume and new price trends.
So, while there are no guarantees, the correlation between stock prices and new index inclusion has been seen to be positive and there’s likely a correlation to increased volume. This is similar to when a mid-cap stock gets onto the S&P 500, though, the impact seems to be greater when a micro cap gets into the Russell 2000. Several studies have suggested the impact is significantly higher by virtue of starting from smaller market caps.
Hedge funds, and other investors (like me), have used this jump in share demand to front run the trade a bit. In most years I will find up to a dozen micro caps that I like fundamentally that look like they will or might be added to the Russell 2000.
I will start buying the microcaps late the prior year and into the New Year on anticipation that there will be increased demand for shares of those companies I have identified as both fundamentally desirable and soon to be included in the Russell 2000. This year is no different, as I own seven micro caps that look like possible candidates to be included on the Russell 2000 in June.
My Microcap Russell 2000 Inclusion List For 2024
I am only including stocks that I think have a fair or better likelihood of Russell 2000 inclusion this year. None of these stocks is guaranteed to be included in the Russell 2000.
Here is a list of seven microcap stocks that are not on the Russell 2000 that I am currently invested in. Some are significantly past $200 million in market cap, some are only flirting with that range.
I have at least a fractional starter position in each, and I have larger positions in a couple. My position sizing is as follows:
- Starter position equals a fractional percentage of portfolio.
- Half position equals 1-2% of portfolio.
- Full position equals 3-4% of portfolio.
- Double position equals 6-8% of portfolio.
Further notes on each stock below the chart. I am working my way from smallest to largest in this table.
Company |
Rounded Market Cap On 4/18/2024 |
My Position Sizing |
Radcom (RDCM) |
$140 million | Starter |
Aemetis (AMTX) |
$155 million | Double |
QuickLogic (QUIK) |
$172 million | Starter |
Spire Global (SPIR) |
$239 million | Full |
Red Violet (RDVT) |
$245 million | Starter |
American Superconductor (AMSC) |
$424 million | Starter |
Applied Optoelectronics (AAOI) | $447 million | Starter |
The smallest companies have work to do to jump the $200 million hurdle and be included in the Russell 2000. I rate all seven of the stocks in the chart as buys right now and suggest buying the basket to spread your bets.
I am including briefs on the two companies I have already written full pieces on and intend to cover for Seeking Alpha Premium again in coming weeks. The rest of the companies will require deeper due diligence by you, however, again, I am invested in all five of them.
Aemetis (AMTX)
I have written about Aemetis more fully on two occasions:
Aemetis Is My Top Growth Stock Of 2023
Aemetis Grows, Pays Down Debt, Promises More To Come In 2024
Aemetis is a biofuels company with refineries in California and India. They also have a new renewable diesel and sustainable aviation fuel plant permitted and ready to break ground this year in California.
The company is about a year behind its original timeline due to tightness in financing. That has been breaking recently though with a string of new sources of financing and revenues.
In an interview I did with CEO Eric McAfee, he discussed raising up to $200 million with a partial IPO of the company’s debt free India refinery that has been increasing capacity out of free cash flow to finance the capex.
The company was recently approved for $196 million in EB-5 funding by the USCIS. And, they received $10.5 million in federal tax credits for biofuels projects. The company also received $63 million in Investment Tax Credits in Q4 last year and expect a similar amount in 2024. Other tax credits are also coming in the form of Production Tax Credits and California Low Carbon Fuel Standards credits.
The company already has low interest long-term financing through the USDA for their already operational renewable biogas (from eight dairy digesters with connected pipeline to local utility) with another $100 million in the approval process for 52 more digesters. Further, their private equity partner, Third Eye Capital, has been funding them for over a decade towards completion of various projects and some of that debt was paid down recently.
Aemetis has about $7 billion in contracts for future delivery of biodiesel and Sustainable Aviation Fuel from many of the top airlines. Tax credits over the next 5-7 years are substantially higher than current market cap and expected capex. So, on net, additive to normal fuels margins.
Financing has been falling in cost, however, their clear core risk is that future financing costs surge or are delayed if rates do indeed stay higher for longer. That could set them back further on their timeline.
Currently at $155 million market cap, this company is furthest away from inclusion in the Russell 2000. The company has been under a furious short attack, with short interest at about 14% in recent weeks after having been at $230 million market cap just a month ago.
Aemetis stock is very volatile. Recently, that volatility has been downward after a lot of movement the past few years. I think the downtrend is about to reverse just as violently. My target price is $25 for the next year. I could be very wrong.
My group of investors bought heavily last May when the stock was about $2. The share price is above that level now around $4 per share. It is definitely a battleground stock with the short interest so high. If the market cap can get high enough for Russell inclusion, then I think there will be a substantial short squeeze. I could be very wrong.
Spire Global (SPIR)
I have written about Spire Global twice and interviewed the CEO:
Interview With Spire Global CEO Peter Platzer (Video & Transcript)
My first piece on Spire Global was horribly early, and I am sure someone will mention it in the comments. But, it is instructive in the use of a very slow scaling in process, which is what I utilize.
Here is my current position for portfolios at Interactive Brokers, where I custody the majority of client accounts for my investment advisory.
Our initial position in Spire Global was tiny. We added substantially just before and after the interview with the CEO. So far, we are up despite being down 80% at one point.
Why did I hold on to the stock? First, it was not impacting performance due to its small position size, and I was very confident in the company’s unique position in the satellite space.
Spire Global has deployed the only RFID satellite network which is being used for maritime, weather, climate, aviation, space service and government uses. Radio frequency is different than the imagery you see from satellites that snap pictures.
The company has been turning profitable on different metrics in the past two quarters. In Q4 they achieved positive EBITDA for the first time at $2 million. Cash flow from operations was at $4.1 million, which was a $9.2 million improvement. Free cash flow was still negative $2 million, but the company expects to be free cash flow positive in Q2 or Q3 of 2024.
Revenues increased for the 10th consecutive quarter and 35% higher than the prior year. 2024 revenue is expected to be about $143 million, much of it contractually recurring, and another 35% improvement. I find that significant as market cap is less than 2x expected revenue. That is an extremely low valuation ratio.
The founder/CEO and other insiders are major shareholders, and institutions have been adding recently. Unlike some of the other companies on my list, short interest in Spire Global has been shrinking and is down to 4.8%.
The company just did a secondary offering at $14 and $14.50 per share to cover upcoming capex and to pay down debt. I think the current price below the secondary price is a good entry point.
Investment Quick Thoughts
I stayed away from clinical stage biotech, despite some big potential upside. There is simply too much risk for me in those names. Russell though noted biotech names specifically as big winners in 2023.
If you buy micro caps, then you have to be ready for fast and wide swings in price. Knowing the companies deeply, as I have taken the time to do, can help stomach the volatility.
One thing I will note, and I am writing a very in depth piece on the subject, is that shorting of microcap and small caps is rampant in the markets right now with a lot of new traders the past four years. Often these shorts are coordinating using trading rooms and social media – it is easy enough to go into their trading rooms and Discords to observe.
All of the companies mentioned have short interests, and some are substantially shorted. It is my belief the shorts are simply overwhelming the float and their reasoning is otherwise suspect. I could be wrong. Maybe they are the smartest kids in the room.
I do not know how the shorted stocks will work out in the short run, but, my suspicion, supported by past history, is that when the markets anticipate interest rates finally falling again, then small caps will do very well. That happens because money managers recognize that small businesses have a higher need for financing, and lower rates support such. That is the historical track record anyway. Remember, your past performance is no guarantee of future performance disclaimers.
I would buy the basket I listed in appropriate sizes that allow you to sleep through the night. Then, I would add to them as their businesses execute, and they reach milestones on revenues and profitability.
I would not try to cherry-pick as that adds too much element of needing to be perfect. If you do cherry-pick, note that my biggest positions are in Aemetis and Spire if that is of any help to you.