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Four hot micro-cap special situations

The rewards far outweighed the high risks of the small-cap special situation screen last year - the five stocks selected have more than doubled in value. Four micro-cap shares make the grade this year.
April 22, 2015

For those investors who dabble in the world of small-cap special situations, it is the promise of potentially massive rewards that tempt them to take on what many would consider unpalatable risks. Last year, my small-cap special situations screen managed to stumble upon one of those shares that makes all the risk-taking associated with deep-value small-caps worthwhile, and overall the five shares picked by the screen managed to deliver a bumper 103 per cent total return, compared with a negative 2.4 per cent return from a blend of the FTSE Small-Cap and Aim All-Share indices.

The stock that produced a real knockout return last year was carpet manufacturer Victoria. Part of the reason it had such a strong run over the year involves the methodology used by Thomson Datastream in calculating total return data. It is assumed that all income received from a stock is reinvested. So when Victoria (VCP) paid a 292p special dividend last July, it was assumed that income was reinvested at the price of the shares following payment, which was about 190p. Since then, despite some concerns about management incentives, the shares have rocketed to 780p on the back of a series of acquisitions. All in all, the total return from the stock since Victoria was selected by last year's screen stands at a jaw-dropping 546 per cent.

 

NameTIDMTotal return (8 Apr 2014 - 15 Apr 2015)
VictoriaVCP546%
Cardiff PropertiesCDFP23%
CaffynsCFYN4.3%
AmbrianAMBR1.1%
Punch TavernsPUB-59%
FTSE Small Cap -6.9%
FTSE Aim All Share--12%
FTSE Small-cap/Aim--2.4%
Small-cap Special Sits-103%

Source: Thomson Datastream

 

But the performance of last year's screen is not all cause for jubilation. Punch Taverns (PUB) provides a sobering example of the dangers involved in chasing very cheap micro-cap shares. Its shares sank under the company's massive debt burden during the year (see table above). Screens are not good at picking up on the nuances of investment narratives and it was clear that there could be some major trouble ahead for Punch at the time the screen highlighted it, which prompted me to describe the shares as a "blind punt". That said, there were reasons for being sceptical about Victoria, too.

I imagine readers will also have little difficulty in finding reasons to avoid the screen's four special situations picks this year, too. Chinese textiles company CamKids (CAMK) strikes me as a particularly controversial inclusion, given the epic disappointment that Aim-traded Chinese companies have proved over the past year. Nevertheless, if you believe the numbers reported by the company, there is massive value on offer. The forecast PE ratio is just over one and reported net cash is worth considerably more than the company's market cap.

In the two years that I have run this high-risk screen, the rewards have outweighed the risks and the overall performance has been a stunning 162 per cent total return, compared with 32 per cent from the FTSE Small Cap and 5.8 per cent from the FTSE Aim All-Share, or 19 per cent from a blend of the two indices. Factor in dealing charges at 4 per cent to take account of the very high spreads micro-caps often trade on, and the cumulative total return over the two years is 145 per cent.

 

 

The key criteria the screen uses to identify 'value' is a low price-to-tangible-net-asset-value (P/TangBV) ratio. This looks at NAV, ignoring intangible factors, such as the value assigned to brands or internally developed software. There are two arguments that I find have strong intuitive appeal when it comes to explaining why investors can benefit from targeting low P/TangBV stocks. On the one hand, such stocks can provide considerable upside in the case of a break-up or a takeover, assuming the company's balance sheet is a fair reflection of the actual value of its assets. The other argument for low P/TangBV stocks is that the ratio can identify companies with strong asset bases that have become temporarily unproductive but could be due to come back. A strong balance sheet can also provide management with a position of strength from which to make change.

 

The full criteria for the screen are:

■ P/TangBV in the lowest quarter of all stocks screened, or the lowest 15 per cent for investment companies.

■ Three-month share price momentum higher than the median average.

■ Year-on-year EPS increase in the most recently reported six-month trading period.

■ A current ratio (current assets divided by current liabilities) of more than one.

■ Positive free cash flow last year.

■ Market cap of more than £10m.

 

I've screened all FTSE All Small and Aim All-Share stocks. Only four made the grade, all of which have sub-£50m market capitalisations. I've provided write-ups below listed in order of strongest to weakest three-month share-price momentum. Handle with care.

 

FOUR SMALL-CAP SPECIAL SITUATIONS