Would You Pay For It?

06/02/2011 04:07 pm ET | Updated Aug 02, 2011

One of the characteristics of toiling in obscurity is the limited shelf life. No sentient being, or company for that matter, can stand anonymity for long. Fortunately, there are three solutions; pray for a miracle, change the perception or shuffle off this mortal coil.

In the case of most SmallCap companies, the equivalent of the third eventuality would be to shut the doors.

Let's deal with door number two -- change the perception -- as the most viable, since miracles only happen infrequently and, dare I say, in obscurity. Other than a fraternity party I attended many years ago in Ithaca, New York, but I digress.

Let's talk fee-based research. Rough segue, but an extremely interesting topic. If you were/are the CEO of a SmallCap company whose stock couldn't get attention if you yelled 'open bar' at an investor conference in Vegas, then you need to familiarize yourself with the genre. As do investors. Once you understand how it works, it amazes me that anyone depends at all on the affectations and frequent conflicts of interest of 'traditional' investment dealer research.

Begin with the premise that your corporate story or vision is worth telling, which doesn't include you 40-something game developers eating hot pockets in mom's basement.

The hell of it is, there are some great stories out there: Lifesaving biotech stories, the next Microsoft (or Apple) or a killer electronic device or cost-saving service. If you can objectively conclude the world needs to know, or alternatively hire someone to tell you it has legs, it probably should gain exposure. And inform potential investors. But how do you get noticed? Fee-based research is a viable arrow in the overall IR quiver.

I gained some good insight chatting to independent analyst Patrick Murphy, CFA, and principal of Some interesting observations:

• SmallCaps tend to commission fee-based research when times for the company are good and want those facts disseminated to investors
• Disclosures on the report are key. Investors must satisfy themselves that the analyst's compensation is fully disclosed as well as their ethics
• CFA's are held to very high standards and having that designation ups the independence and credibility of the work
• No matter how informational and conflict-free the report, it must be used a one of many research tools. Never make an investment decision based on one report
• If a report is too promotional or draws unrealistic conclusions and/or price targets, it should likely be ignored
• The majority of fee-based research shops do not take shares as compensation, thereby negating a vested or conflicted interest in the market performance of the shares
• The research should work for the investor, not the company

In the majority of cases, the company does not see -- if the report contains one -- the analyst's price target or rating until publication. The reason is to maintain the independence of the report and not allow the company to exert any influence on the projected price. The company always has the right to spike the report if it feels there are problems, but since investors will never know, the point is moot.

The main enigma for investors is that fee-based research is likely going to be positive. A company facing bankruptcy or some other calamity is not going to bring attention to it. Plus, it likely doesn't have the money to pay for a report. I don't see this issue as a problem, based on the fact that if these reports are used first and foremost as information sources, the investor takeaway is an in-depth history of the company, good rundown of the financials, comparison to the metrics of peers and a sense of future direction. Analysts, especially those with CFA designations, are not in the habit of making stuff up. The numbers are the numbers and all those used for the report are already freely available to the public.

Investors should never confuse a positive tone with a flattering or pandering one; alarm bells should sound if the tenor of the report is overtly gushy.

Compared to Wall Street, or traditional investment sealer research, fee-based reports give -- or should -- a clear picture of all compensation. 'Traditional' research rarely does this and while I draw no conclusions as to why, wouldn't an investor just rather know? All a reputable fee-based analyst receives is a disclosed cash payment. No soft dollar arrangements, no investment banking relationships and no axe to grind.

For my money, or rather a SmallCap company's money, that seems a good deal for all involved.