This strategy has paid off this year with a host of companies on my active watchlist seeing their share prices double or even treble in some cases. Indeed, on the back of sharp re-ratings, I have recently been forced to update the investment case on no fewer than 11 holdings that have each produced a total return of 100 per cent or more since I initiated coverage including online gaming company 32Red (TTR:99p); defence firm Cohort (CHRT:420p); wafer reclaim services company Pure Wafer (PUR:165p); telematics specialist Trakm8 (TRAK:270p); housebuilder Inland (INL:71p); engineer Trifast (TRI:121p); hospital superbug decontamination specialist Tristel (TSTL:142p); financial services companies Fairpoint (FRP:172p) and STM (STM: 68p); software company and consultancy KBC Advanced Technologies (KBC:134p); and high street retailer Moss Bros (MOSB:105p).
I have also updated my view on a number of other active buy recommendations which have produced total returns of at least 70 per cent. These include shares in AB Dynamics (ABDP:320p), a designer and maker of advanced testing equipment for vehicles; software company K3 Business Technology (KBT:377p); Bilby (BILB:136p), a provider of gas heating appliance installation and maintenance services to residential and commercial properties; Redde (REDD:160p), a provider of replacement vehicles for drivers involved in accidents that are not their fault and of legal services designed to assist claimant parties in partnership with leading insurers; uPVC window company Safestyle (SFE:237p); Stadium Group (SDM:120p), a specialist provider of niche electronic technologies; cinema group Cineworld (CINE:522p); and Aim-traded insurance sector investment company BP Marsh & Partners (BPM:157p).
The updated articles on all these 19 companies are published on my home page of our website. In each case, I would continue to run profits.
Banking profits and cutting losers
That's not to say that I am averse to banking gains. Indeed, earlier this year I recommended crystallising a 400 per cent gain on shares in Netcall (NET:55p), a company whose smart software makes call handling more efficient for organisations; FTSE 250 property group Daejan (DJAN:6,000p) whose shares had doubled; and housebuilders Barratt Developments (BDEV:586p) and Taylor Wimpey (TW.:187p), albeit I was a bit premature at banking the substantial gains on those holdings.
It goes without saying that not all my recommendations work out as well as these. Indeed, it's only right to point out that if I had run strict a stop-loss policy then losses on my losers would have been contained and would not have taken some of the shine off the aforementioned gains. The four laggards that immediately spring to mind are Chinese clothing retailers Camkids (CAMK) and Naibu (NBU), commodity investment company Polo Resources (POL) and marine support services company SeaEnergy (SEA), all of I should have cut my losses earlier than I did with hindsight.
Clearly, taking a hit on some of your holdings is part and parcel of the investment game, but limiting paper losses is too. Equally, I would hope that those of you who bought into those situations also had some exposure to the list of the 23 winners above that have produced an average gain of well over 100 per cent per holding.
Bid watch
I would also point that I have been actively adding to the shares I cover and have initiated coverage on around 35 under researched companies in the past 10 months, in part driven by the fact that a large number of the companies on my active buy list have succumbed to takeover bids. In fact, eight have made a stock market exit and another four are in play right now. The completed takeovers have so far reaped average gains of 25 per cent on my recommended buy-in prices including a 36 per cent quick fire profit on Anite, a leading supplier of test and measurement systems to the global wireless market, which received a cash offer from Nasdaq-listed Keysight Technologies (KEYS:NYQ) three weeks after I advised buying.
As I noted in my recent online columns ('Bid watch', 23 November 2015), I expect further decent gains to be reaped on bid situations in four other companies: Aim-traded Plethora Solutions (PLE:5.75p), a UK-based speciality pharmaceutical company dedicated to the development and marketing of products for the treatment and management of urological disorders; Renewable Energy Generation (WIND:54.5p), an Aim-traded renewable energy company; Bioquell (BQE:143p), a provider of specialist microbiological control technologies to the healthcare, life science and defence markets; and Ensor (ESR:110p), a Manchester-based products and services company focused on manufacturing and supply of physical security products and packaging. Pure Wafer is heading for a stock market exit too and one which will crystallise at least a 133 per cent gain in the two years since I initiated coverage.
The important point I am trying to make is that successful investing takes discipline and patience, not to mention a vast amount of research and investment analysis to accumulate the winners on the scale I have been fortunate enough to report back to you this year.
Earnings growth at a reasonable price
Bearing this in mind, one of the most important investment techniques I have learned was from the late Jim Slater, a well known value investor and the author of 'Beyond the Zulu Principle: Extraordinary profits from ordinary shares' and 'The Zulu Principle: Making Extraordinary profits from ordinary shares'. They are must reads for any investor, in my opinion.
In particular, Mr Slater contended that re-ratings can turbo-charge returns from shares when above average earnings growth is first recognised, so the key is identifying companies with good growth prospects at a reasonable price. This is referred to in the investment world by the acronym GARP. Of the under researched small-cap gems I have uncovered this year, Trakm8 is a classic example of this. That's because when I first advised buying the shares at 92p ('Zoning in on a profitable price move', 16 Feb 2015), analyst Lorne Daniel at brokerage finnCap predicted the company would deliver EPS of 8p in the 12 months to the end of March 2016, up from 5.7p a year earlier. On that basis, the forward PE ratio was 11.5, hardly a punchy rating for a business winning a raft of new contracts with major insurers and benefiting from some astute acquisitions too.
However, nine months on and several earnings upgrades later, Mr Daniel now predicts EPS will come in at 11.3p in the current financial year, representing an almost doubling of earnings. And because investors are far happier to pay a premium rating for high growth shares, this earnings upgrade cycle has driven Trakm8's shares up by 200 per cent since I recommended buying.
Or put it another way, the stellar growth in net profits only accounts for half the share price gains, the balance is down to investors ascribing a far higher earnings multiple to these rapidly rising earnings: the shares now trade on 24 times forward earnings, or double their forward rating back in February. And the company is likely to maintain its premium rating as long as Trakm8's board can successfully deliver EPS of almost 16p in the financial year to end March 2017, as analysts predict. On this basis, the shares are priced on 16.5 times prospective earnings for the coming financial year, a rating that reflects the prospect of EPS rising by a further 41 per cent.
The same is true of my recommendations on Cineworld, Cohort, Redde, STM, K3 Business Technologies, AB Dynamics and Tristel. These companies may operate in a wide variety of sectors, but they had one thing in common when I recommended buying the shares: their potential double-digit earnings growth was being significantly underpriced by investors. In simple terms, I was assessing the valuations not only on peer group analysis, but by determining whether their PEG ratios, the prospective PE ratio divided by the average annual increase in EPS, was favourable too. The key here is trying to identify underpriced growth companies where the PEG ratio is around one or less, so there is potential for earnings expansion to turbo-charge share price re-ratings.
Classic value investing
It's also fair to say that a large number of my stock picks are classic value shares. My strategy here is to search for companies offering: solid asset backing, and preferably where the market capitalisation is below net asset value; decent cash generation to provide shareholders with a sustainable dividend and the board with funds to invest wisely; and potential for solid profit growth to drive an earnings multiple expansion.
A great example of how this works in practise is Eastern European property fund manager First Property Group (FPO: 47.5p). Shares in the Aim-traded traded company have risen by almost 20 per cent since I recommended buying ahead of last week's interim results ('In pole position for a re-rating', 7 Oct 2015), and are closing in rapidly on my target price of 49p. They have performed well over the longer-term too, having risen by 156 per cent since I initiated coverage at 18.5p in my 2011 Bargain Shares Portfolio. That compares favourably with the 21 per cent decline in the FTSE Aim index in the same period.
The 1.06p a share annual payout I locked into provided a yield close to 6 per cent on the original purchase price, so once you factor in cumulative dividends of 5.37p a share in the past four and a half years then the holding is showing a total return of 183 per cent. This income stream has been growing too as following a 10 per cent hike in the payout at last week's results, analyst Chris Thomas at house broker Arden Partners predicts a full-year dividend of 1.48p a share, up from 1.08p in 2011, implying a current forward yield of 3.1 per cent.
Part of the thumping share price gain reflects the fact that the company has doubled its reported net asset value to £32m in the intervening period, but it also reflects the hidden value on First Property's balance sheet too. Indeed, marking assets to their market value raises the company's current book value by almost half again to £47.6m, or 40p a share. This means that the shares are trading on a 20 per cent premium to their adjusted book value rather than a 3 per cent discount when I initiated coverage. The re-rating also reflects an earnings multiple expansion.
That's because back in 2011 First Property's shares were trading on seven times reported EPS of 2.7p for the financial year to end March 2012, whereas they are now priced on 10 times EPS estimates of 4.9p for the 12 months to end March 2016. So half of the 156 per cent share price gain is down to First Property earnings growing by 80 per cent in the past four financial years, and the other half reflects the higher earnings multiple investors are now willing to value the business on. Moreover, I can see potential for more upside too because with directly owned properties providing a solid recurring income stream to support the dividend, cash available for earnings accretive acquisitions, and mandates wins starting to build up new income streams, prospects look well underpinned.
Clearly, there are many investment strategies that work, but for me focusing on GARP analysis, value investing and exploiting bid situations has certainly paid off handsomely.
Please note that for a limited period of time, my book Stock Picking for Profit is being offered for sale at a promotional price of £11.99 plus postage, subject to availability, full details are enclosed below.
MORE FROM SIMON THOMPSON...
I have published articles on the following companies since the start of last week:
■ Ensor: Buy at 99p, target 125p ('Bid watch', 23 Nov 2015)
■ Marwyn Value Investors: Buy at 216p ('Cashing in on a top performer', 23 Nov 2015)
■ Trakm8: Run profits at 262p ('On track for record earnings', 24 Nov 2015)
■ Walker Crips Group: Buy at 49p, target 60p ('Profit from a profit surge', 24 Nov 2015)
■ Renew Holdings: Buy at 362p, new target range 390p to 400p; Cambria Automobiles: Buy at 73p, new target 90p; Tristel: Run profits at 142p; Pure Wafer: Sit tight at 165p and await details of capital distribution ('Running small cap winners', 25 November 2015)
■ Cohort: Run profits at 418p; Inland Homes: Run profits at 70p ('Riding momentum stocks', 26 November 2015)
■ Record: Hold at 28.75p ('Record awaits the Fed decision', 26 November 2015)
■ For a limited period and strictly subject to stock availability, Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com at a special promotional price of £11.99, plus £2.95 postage and packaging, or by telephoning YPDBooks on 01904 431 213 to place an order. It is being sold through no other source. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
