A key way my small-cap special situations screen has generated outperformance over the past three years (a 72.6 per cent cumulative total return compared with 5.7 per cent from Alternative Investment Market and 19.8 per cent from theFTSE Small Cap) is by taking on huge amounts of risk. Unfortunately, fortune does not always favour the brave and last year was a case in point. While this screen can be expected to regularly throw up big losers, its failure last year was in not finding any big winners among the four deep-value stocks it highlighted.
It was not hard to see the potential for some major losses from last year's screen at the outset. A particularly risky looking choice was an Aim-traded Chinese fashion company called Camkids, which purported to have loads of cash but was nevertheless trying to save money on dividend payments. This was made all the more suspicious by the fact that several similar ventures with similarly strong balance sheets had recently collapsed. Over the 12 months Camkids went the same inglorious way as those other failures (I hope my write-up of the stock at the time of last year's screen was suitably cautionary).
| Name | TIDM | Total return (21 Apr 2015 - 25 Apr 2016) |
|---|---|---|
| J Smart | SMJ | 15% |
| Sylvania Platinum | SLP | -32% |
| 600 Group | SIXH | -35% |
| Camkids | CAMK | -100% |
| FTSE Small Cap | - | 2.2% |
| FTSE Aim All-Share | - | -1.3% |
| Small Cap Special Sits | - | -38% |
Source: Thomson Datastream
Nevertheless, in previous years the gung-ho approach of this screen has produced superb results and in the three years I've run it the cumulative total return has been very strong. Building in an annual 4 per cent charge to account for the dauntingly wide spreads on many small-cap shares, the cumulative return drops from 72.6 per cent to 52.7 per cent, which is still well ahead of the indices the screen uses as its hunting ground, which are the FTSE Aim All-Share and FTSE Small Cap.
The small caps special sits rollercoaster
This year, the screen could possibly be regarded as less risky than normal due the larger number of stocks selected. This is not down to any changes I've made to the screening procedure, but as a result of the inability of the screen to find any stocks that meet all its criteria. Because of this, the screen results this year are made up of stocks that pass the screen's key valuation test as well as its minimal market cap cut-off, but fail one of its remaining criteria (detail of the tests failed are listed in the table below). However, while a greater number normally means greater diversity and therefore less risk, it is of note that the screen results have a clear focus on resources stocks, which make up two-fifths of the screen's share picks. These stocks play to the screen's requirement for shares with a low price-to-tangible-book-value (P/TangBV). The screen's criteria 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 written up three stocks below that typify the stocks making it into this year's screen: an illiquid micro cap, a resources company and an esoteric investment/property company. Fundamental data relating to these stocks, along with the screen's 16 other share picks, are listed in the table that follows, which is ordered from strongest to weakest three-month momentum.
THREE SMALL-CAP SPECIAL SITUATIONS
