More downside than upside: knife jugglers at a fair in Texas

    More downside than upside: knife jugglers at a fair in Texas

    Catching falling knives

    3 October 2015

    There is a curious pleasure to be had watching stocks plummet — as long as you don’t own them. It’s not exactly schadenfreude, more the frisson of thinking you might spot which of those stocks might sooner or later bounce back up again.

    Recent market turmoil has revived the perennial temptation to buy bombed-out stocks. The old market saw ‘beware of catching falling knives’ warns us not to do so, but it seems at variance with the Blessed Warren Buffett’s advice to buy when there is blood in the street — he meant Wall Street — and sell when there is unbounded optimism.

    No doubt there is lots of statistical evidence that will support the cautious investor who never buys crashed stocks. But the cautious investor also never makes fortunes in the short term. And that’s the challenge for the ‘veteran investor’ — or at least this one —who must leave the longer term to younger generations while his own focus gets shorter and shorter.

    Experience and healthy cynicism can be used to reduce the risks of this game. With institutional funds dominating most securities markets, it’s best for the small investor not to play in the same pool as the big boys. But the smaller company sector — below £100 million market capitalisation — is different. This is an area major institutions rarely enter, so in theory the playing field is more even.

    Shares that might provide rich pickings for the bottom-fisher tend to have started their descent several years ago, rather than last month. Recent turmoil may have reduced liquidity, but won’t have changed key indicators that distinguish recovery candidates from the terminally doomed. Here they are:

    New management This should give investors hope, especially when the new boys have changed the business plan and committed their own cash. But beware: turning a business around takes time, and can involve write-downs that create even worse short-term results. Occasionally a new team brings a completely new business into the company: in that case, the questions are whether the new business requires funding, and is there a rights issue to follow?

    The balance sheet Cash and no debt is always best. When the market smells that a company is running out of cash, it is remorseless; a long slide downwards for the stock price usually signals the problem. Avoid!

    Who is the major shareholder? Be wary of a big-name investor who has many calls on his time; a small company might be low on his priority list.

    Do your own research Managers and their brokers may be reluctant to talk to small investors — so search the web, read the press and rely on that most uncommon of attributes: common sense.

    Above all, be patient Even when you’ve picked a winner, you’ll probably have to wait longer than you hoped. And when upward momentum starts at last, the temptation will be to say a quick prayer of thanks — and sell. Don’t: the fun could just be starting. You took a risk in order to have a chance of making several times your investment, so why settle for the first 10 per cent rise? Hang in there!

    With those rough guidelines in mind, the opposite page shows a selection of Aim-listed stocks at which I’ve been taking a closer look.

    New brooms, new plans: Aim stocks with upside potential

    DP Poland (Market cap £25.4m at 19.5p)
    New management has gradually turned around this Polish franchise of Domino’s Pizza. Revenues are growing and losses reducing. The hope is that £3 million in the bank should be enough to finance new store openings and see them through to profitability in 2016. The shares stood above £1 four years ago; after a long, slow slide to 9p, they lurched up to their current level in March and have remained there for six months. Time for another lurch?

    Camco (Market cap £12m at 4.75p)
    This is the classic case of a failed business model, new management and a change of plan — and a share that fell from 22p to a penny, then recovered to 5p. Of course the time to have bought was three years ago at a penny — but since then the acquisition of a controlling interest in a developer of power storage technology and a joint venture with a large US engineering fabricator, Jabil, have transformed prospects. Camco’s valuation hardly recognises its involvement in the multibillion-dollar potential market for energy storage — or so say brokers FinnCap.

    Goldplat (Market cap £5.7m at 3.38p)
    Here’s a company that made a wrong turn into mineral exploration and has decided to go back to its original business: recovering small amounts of gold by treating waste products of gold mining and refining. New management brought enhanced techniques to the process and have now achieved positive cash flow. The shares took three years to descend from 16p to 2p but for six months the price has been stable and a recent uptick might be an early signal of a long-awaited recovery. Any improvement in the gold price would also be a bonus.

    Blur Group (Market cap £19.3m at 41p)
    The above-mentioned Blessed Warren Buffett is a hero of mine, and I would normally agree with his dictum never to invest in areas you don’t understand — but this company stands out as a classic fallen angel even if its business model is a bit of a blur to me. In 2013 the share price was £7.50; now it’s showing signs of life again. The company modestly describes itself as ‘the world’s largest online market place for business services’, and nine months ago it had $17 million cash remaining from a $22 million fundraising in 2014. Hopefully enough remains to see them through to the sunny uplands of profitability. Certainly their impressive but long-suffering list of institutional shareholders will be hoping that a more focused business plan and a new finance director will produce the miracle they’re all hoping for. Perhaps there’s a chance to join them in the lift as it rises from the basement?