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Aiming for Ten- Baggers
Where should investors look for substantial rewards during times of financial uncertainty?
As the Euro Army of debt gathers on the shores of deflation looking across the Channel of low growth and political uncertainly; the casualties are mounting up – oil price, copper and a generally lacklustre market performance and private clients become the walking wounded.
Small Stocks Hurt
Over the last year the FTSE 100 has improved 7.8%, the FTSE 250 improved 7.1% while the Aim All Share is off 19%. A terrible relative performance, but please keep with this narrative as we could be approaching Ten Bagger territory. To understand the opportunity perhaps some theory will help. News flows less frequently from small caps, who also find it difficult to engage media interest other than from specialist publications. Market makers become reluctant to hold slow moving stocks which is indicated by wide bid offer spreads tending to reduce trading volume further. Hurt, depressed and of little interest, small caps ought to be cut out of portfolios.
Hide the Axe Eugene
The Theoretical hunt starts. According to Eugene Fama, a 1960’s guru, market efficiency can be divided into three main categories and then graded into ‘weak form, ‘semi-strong-form and ‘strong-form’ efficient. To cut to the chase as I am sure you do not have the time; the more efficient the market the less likelihood there is of finding undiscovered value as the market price already reflects all the possible news. Risk and Proportional Value Blue chips respond more quickly to ‘systematic’ risk, this is the risk of being in the market. A bit like being in the wrong place at the wrong time and its nothing personal. So share prices quickly respond to currency fluctuations, commodity price and political changes. Studies show that this type of risk accounts for 25%- 45% of a stock’s total risk, and the smaller the stock the lower this risk.
So stealthy hunting in the undergrowth of the financial news; Small Cap prices are more responsive to ‘unsystematic risk’ so the price should eventually change, when investors hear the ‘personal’ news events. Events include; winning a significant contract, a jump in earnings, paying its first dividend, director buying shares, predatory stake building, an earnings enhancing acquisition. Add the mathematical theorem of Proportional Value and Volume Acceleration. As a picture this is ‘elephants’ can-not gallop in a china shop. It means that a small change in the price of a penny share creates a large percentage difference in value. Added to this, a small increase in volume, when market markets are flat makes them move their prices and narrow the spread.
So pulling it all together imagine being a shareholding in a depressed penny share company reporting all the above in a sequence of announcements. The term you may remember is “Ten Bagger” which is a tenfold increase in value (£5,000= £50,000). Additionally, in an EIS Fund you can claim 30% Income tax relief and after three years sell it capital gains tax free.
As advisors to the Beaufort Smaller AIM Companies EIS Fund, we follow small caps every day and have done so for far more years than it is polite to remember, the worry lines etched on our faces, may however date us. We are on the ground floor looking for companies where the traction in the business strategy is not being adequately valued and as Corporate Brokers we can help improve the markets efficiently. We are at least theoretically in the right place at the right time hunting for Ten–Baggers.
Jon Levinson is an Advisor to the Beaufort Smaller AIM Companies EIS Fund.
If you have questions about how an EIS Fund works or about our fund pleases call Steve Sahota on 020 7382 8303 and he will endeavour to assist you. steven.sahota@beaufortsecurities.com
