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Small Company Investing: Selecting Profitable vs. Unprofitable Companies


Small Company Investing: Selecting Profitable vs. Unprofitable Companies

New York, NY, InfraCap Market Update - When constructing a portfolio, we believe it is important to select profitable companies as they tend to dramatically outperform unprofitable companies. Long-term returns from owning stocks are almost always driven by profitable companies investing retained earnings in attractive investment opportunities with attractive returns. Most companies retain at least 70% of their earnings and on average invest in high-return projects or repurchase shares with an approximate average after-tax return of 15%. Consequently, companies typically grow earnings at approximately 10%, which is a multiple of the retention rate of 70% multiplied by the after-tax return. Compound earnings growth causes stock prices to rise steadily over time even if the market multiple declines somewhat, and thus the stock price of a company should be substantially higher over time, which benefits long-term investors.


Conversely, money-losing companies have the opposite dynamic in that the losses from operations must be covered by issuing new shares, which reduces shareholders’ percentage interest in the company over time. It is also extremely difficult for unprofitable companies to become profitable depending on the exact business model. Many unprofitable companies never become profitable and shut down or go bankrupt. In the past, only profitable companies were allowed to go public as money-losing companies were too risky to sell to the public.


Our analysis of the returns of profitable companies vs. unprofitable companies indicates that profitable companies outperformed unprofitable companies by 1.51% per year since 2000. In addition, the profitable companies were less volatile than unprofitable companies with a volatility of 19.50% vs. 20.11% for unprofitable companies over the same period*.

Our small cap income fund, SCAP, is constructed with companies that are profitable, pay substantial dividends, and trade at reasonable multiples of growth plus income to earnings. We believe that these companies are less risky than money-losing companies, and that companies that pay dividends are on average higher quality than non-dividend payers. SCAP enhances cash flow and dividend coverage by investing in preferred stocks and writing covered index call options. In our view, the combination of investing in profitable dividend stocks and enhancing yield through preferred stocks and options potentially provides an opportunity to generate stable income from small cap stocks with less risk than investing in the broad Russell 2000 small cap index.


If you have an interest in the InfraCap Small Cap Income fund, SCAP, please contact us by emailing us at investors@icmllc.com or calling us at 212-763-8336.


Also, please see our complimentary small cap primer for more information about

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