June 23, 2005
Panning for Gold: Principle Profits Applies Socially Responsible Investing to Microcaps
by William Baue
Massachusetts firm examines financial, social, and environmental performance to identify future
Socially responsible investment (SRI) tends to focus on large capitalization companies, those that
exert the biggest influence on society and the environment and hence worthy of supporting for their
responsible behavior and reforming their irresponsible practices. There are significantly fewer
mid- and small-cap SRI opportunities. When it comes to microcaps (companies with $500 million in
market capitalization or less), arguably of equal importance as incubators of the next generation
of corporate practice, there is a relative void in the SRI community. One exception is Amherst,
Massachusetts-based Principle Profits Asset Management.
"I don't know of any of socially
responsible microcap manager," said Dan McKenna, Principle Profits' portfolio manager, who founded
the firm in 1992. "To me, microcaps are the most interesting and underserved part of the market--I
don't know why anyone would need me to tell them to invest in Intel."
Of course Intel
which is included in many SRI portfolios, was once a microcap. Founded as Integrated Electronics
in 1971 by Hungarian immigrant Andrós Króf (who later Americanized his name to Andy Grove), the
company went on to generate profits characterized by the Motley Fool as the "largest legal creation of wealth in history."
"It's like panning for gold in a way," Mr. McKenna told SocialFunds.com. "Of the 16,000
publicly-traded stocks, there are thousands and thousands of tiny companies on the margins of the
investment world where that whole efficient market theory just doesn't work--not all information is
known by all people at all times, so there's a lot of inefficiency in pricing."
on the bus sometimes and you have to wait a while for the market to catch up with your
'brilliance,'" he added.
To identify microcaps that exhibit "GaaRP" ("Growth at a
Reasonable Price") characteristics, Mr. McKenna applies the proprietary ten-point "Principle
Profits Ranking" system. This system examines traditional factors such as price-to-earnings and
price-to-book-value ratios, return on equity, and cash flow, ranking companies on a scale from 0.0
to 10.0, with 6.5 as the minimum threshold for investment consideration.
then conducts a social issues assessment, grading companies from A+ to F, with a B grade as the
minimum threshold to qualify for the investment universe. While most SRI asset managers purchase
information about corporate social and environmental performance from SRI research firms, microcap
SRI research is as scarce as microcap SRI asset management.
"We do all our own
tire-kicking," said Mr. McKenna. Principle Profits employs anywhere from four to eight interns
every semester who help with social issues research, sending out questionnaires on social and
environmental issues to each microcap considered for investment, following up with telephone
interviews. "We try to talk to as many of the management teams as possible."
Principle Profits team also conducts web-based research, which has its own challenges.
you Google Intel, you get 8,000 hits; you Google Mity Lite [MITY and you might get four," Mr.
McKenna points out.
Interestingly, Mr. McKenna considers it more difficult to identify
socially responsible large-caps than socially responsible microcaps. To illustrate his point, he
draws an analogy to children and adults
"Microcaps are like children--they're young and
small and haven't had a chance to grow up and get corrupted yet--they have maybe 250 employees
instead 25,000, they're usually very focused on a particular product or service instead of ten
different divisions each with nine different things going on," he explained. "You don't find a lot
of microcaps in the big uglies--the defense industry, oil, chemicals."
tend to focus on market opportunities that are socially and environmentally beneficial, or at least
"We invest in a lot of alternative energy companies, solar companies, fuel cell
companies, companies that are producing biomedicals," Mr. McKenna said.
Nature's Sunshine (NATR) is a Provo, Utah-based
company with a $250 million market capitalization currently trading at about $17 a share that
produces vitamins, biomedicines, and nutria-ceuticals.
"Nature’s Sunshine passes all the
negative screens--they're not in nukes or weapons--and on the positive side, they are creating
employment opportunities for people wanting to become their own employer, distributing products
that are natural and healthy," said Mr. McKenna.
While the majority of Principle Profits'
clients are high net-worth individuals (typically Generation Xers inheriting money from Baby
Boomers), the firm seeks to expand its reach in microcap expertise to a broader client base.
"Our intermediate-term goal is to open a socially responsible microcap mutual fund," said Mr.