Of particular interest to us at DCORP is the idea of venture capital investing. Venture capital is the financing that investors provide to startup companies and small businesses that are believed to have long-term growth potential. These companies are in their early stages of development and require additional capital for expansion. Most of these venture capital ideas do not have earnings. Since stocks are nothing more than earnings engines, established engines have to be treated differently than startup ventures. So, when these venture capital companies do at some point get listed on the stock market, how do we value them? We have to rely on the ‘smart money’!
So, who is the ‘smart money’? These are the people that are also referred to as ‘insiders’. These could be current large shareholders that have the capital to pay for research or the directors of the company that are currently running the show. Who better to know the future prospects of a company than these guys!? If they are investing, we want to follow their footsteps!
So, what do we want to be looking for to get an idea of what the insiders see as value? There are a few different signs. The first one is options to directors. Directors are often given incentives to perform through the issuance of stock options. Where are the directors incentivized to get the stock price above? The second signal is open market activity by the insiders. Because any owner of a publicly traded company that owns more than a certain percentage of that company (5% in North America) must report their activity, we can sometimes get a nice idea of what they believe to be of value. If they sell, we should be warned that they might consider the stock to be overpriced. If they’re buying, it might mean that they believe there are good times to come for the company. The third signal is investors taking equity in place of debt. If insiders prefer to have the potential for dividends and capital gains in favor of a guaranteed income of interest payments, this is often a sign that they see a bright future ahead!