Time to capitalise on LMS

The obvious starting point is companies that are reliable dividend yielders and offer good free cashflow which means there is scope for rising and well-covered payouts. I am also on the lookout for businesses with potential for positive earnings revisions so there is a good news story to tell, too. But this must not be priced in already, so I generally target companies on historic single digit PE ratios, but ones where there is a realistic chance of positive earnings per share (EPS) growth over the next couple of years. I also try to buy in at below net asset value (NAV), or on a modest premium, which means that I am not overpaying on a price-to-book value basis.

In addition, I am also attracted by companies that have shown relative strength against the market during 'risk off' periods so there is firm evidence of investors accumulating stock even when the general market is falling. This is one reason I am taking a closer look at shares in small-cap investment firm LMS Capital this week. In fact, the shares have not only has been rising in a falling market, but I strongly believe they could realistically offer us a further 25 per cent upside over the next 18 months. Or put it another way, a potential gain of that magnitude translates into a compound annual growth rate of 16 per cent, a rate of return that any fund manager would be happy to take in any environment let alone this one.

The reason I am confident of making such a healthy return is because LMS is in the process of selling off its investment portfolio and winding itself up. So when the company announces interim results in early August we can expect some news on the first distribution to shareholders due to be paid by the year-end. The plan is to return all the company’s cash back to shareholders by the end of 2013.

But this is yet to be factored into the share price because, with the shares at 64p, LMS only has a market value of £175m, a hefty 27 per cent discount to its March 2012 NAV of £240m, or 88p a share. In turn that creates real potential for the share price discount to NAV to narrow as LMS disposes of its assets. More important, I firmly believe there is a realistic chance of a minimum of 80p a share being paid out to shareholders between now and the end of 2013 to create the 25 per cent gain mentioned above.

That's because I have analysed every single major investment LMS has made and have noted that half the portfolio is invested in nine holdings, mainly US and UK funds and unquoted investments in companies in the following sectors: technology, property, energy and consumer facing industries. It’s worth pointing out that only one of those holdings – a quoted investment in Weatherford International with a book value of £19.3m – fell in value last year. In fact, all the other eight investments rose strongly in value which should help to generate interest from potential buyers in the sale process especially since several of these unquoted investments have been reporting bumper trading news lately. It's also worth noting that LMS is currently sitting on a £31.6m cash pile, worth 11p a share, so is in a healthy financial position to get the best possible price for its investments.

LMS Capital largest investments

Of interest, too, is the fact that the company's share price has just given a strong buy signal having broken to the upside out of a rising triangle chart formation. In my view, LMS shares look a pretty compelling and safe-looking investment over the next 18 months and, on a bid-offer spread of 63.5p to 64p, they are well worth accumulating ahead of the first-half results in August.

Small-cap updates

My 2012 Bargain share portfolio has turned into a resilient performance during the market turmoil and remains in positive territory. This compares favourably with the FTSE Aim index which is down 14 per cent since mid-February and the FTSE All-Share which is down over 5 per cent.

How Simon Thompson's 2012 Bargain Share Portfolio has performed

However, one company – carbon emissions investment company Trading Emissions – is dragging down the overall performance of my portfolio. In fact, having initially risen 20 per cent on my advised buy-in price of 25.25p, I am now nursing a similar sized loss on the holding after retail investors dumped more risky investments during the market fall-out. In my view, they have overreacted because, at 19.5p, the shares are trading on an unwarranted discount to book value of 74p even though Trading Emissions has net cash of 25p a share, a private equity portfolio with a book value of 56p and a carbon portfolio with a negative net worth of 7p a share.

Analyst Andrew Shepherd-Barron at Peel Hunt notes that even if you write-off 50 per cent of the private equity portfolio and charge £10m for wind-up fees NAV would still be 48p. And even if you take the worst case scenario and assume a carbon price of zero, NAV is 50 per cent higher than the current share price. So although the shares have enjoyed a rollercoaster ride, I still see significant upside potential if you have the patience and stomach to ride out the short-term volatility.

■ I am taking a well-earned holiday over the next fortnight and my next column will appear online at 12pm on Tuesday 10 July.