Guest Insights: Emerging-market small caps

David Riedel is founder and president of Riedel Research Group, which provides independent equity research focusing on emerging markets Asia, Latin America, and Europe. Prior to founding this firm, Riedel worked as an analyst at Salomon Smith Barney in New York and Bangkok. While overseas, he supervised a twelve-person research team covering telecommunications companies and other industries in Southeast Asia. While in New York, Riedel covered business services stocks, including staffing and outsourcing, as well as small-cap growth companies in the automobile and motor sports industries.

In an interview with SmallCapInvestor.com, Riedel talks about the current environment for emerging-market small caps, and names three of his top picks.

Explain your investment process and criteria for investments.

Riedel Research has 30 analysts on the ground in 15 countries around the world. These analysts scour their local markets for investment opportunities that are being misunderstood and mispriced by the market. Because of our local presence and knowledge we are able to understand better than someone based somewhere else how competition, political, local trends and management strategy are playing out. By identifying shifts in local sentiment or changes in regulation and strategy earlier than everyone else, we help our clients make money. Once we have validated the trend, we apply rigorous fundamental analysis focusing on cash-flow and margins to find the best way to play the theme.

What advice are you giving to individual investors right now regarding investing in small caps in the emerging markets?

I am cautiously optimistic about the opportunities in emerging market small-caps. My advice to investors about smaller names in these markets has remained consistent – invest in companies where you can understand the business model, where the balance sheet is strong and sell at the first sign of a mis-step. Understanding the business model is key. If you happen to know something about Internet search, automobiles, cellular service or retailing you will have a major advantage in picking the right investments.

I do not mean that you have to be an expert in the field but an understanding of how the company collects money and makes profits is tremendously helpful. The balance sheet is the place to start with small-caps – definitely before the income statement. You need to understand how the company has financed itself and what the risks are from that financing. Because of their nature as primarily growth stocks in earlier stages of development, many small cap companies have too many shares outstanding or too much debt and this prevents even strong top-line trends from getting earnings to the bottom line. You have to start with the balance sheet.

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