Small Cap Value Report (5 Dec 2014) - NBU, OUT, WTM

5th Dec '14 by Paul Scott

39 comments 22666 reads

Good morning!

It's tough still out there in smallcapsville. Certainly for AIM the party is over, with the FTSE Intl-aim All Share Index (FTSE:AXX) having given up all of the 2013 bull run, and now 21% down from its peak in Mar 2014. Although fully listed small caps have fared somewhat better (the beige comparison line on the chart below). You can sometimes feel confidence melting away with small caps, and it feels like that again at the moment.

Chinese stocks

I've warned readers about these shares many times, so hopefully prevented some losses for you. It looks very much as if we're fast approaching the inevitable end game of these small Chinese stocks de-listing from AIM and disappearing without trace.

I see Naibu Global International Co (LON:NBU) is now down to only 8.5p, over worries that it won't be able to find another NOMAD following Daniel Stewart losing its NOMAD licence. Of course if the company was genuine, then insiders would be buying the shares in droves at this price. But it isn't, so they aren't!

As Was Shakoor said in a recent audiocast with me, whenever he's come across a company where he's had to seriously question if the numbers are real, they NEVER are real! He couldn't remember a single case which ended well, where the figures had looked too good to be true, or were otherwise seriously questionable. That's worth keeping at the front of your mind, and it's certainly helped me side-step a lot of the worst shares this year.

You also have to remember that AIM is the Wild West of the investment world. There are a lot of companies on AIM which are just plain bad - with dishonest management, and false accounts. Audits mean nothing, and regulation is totally ineffective. So very much a case of caveat emptor. It's also a great pity because there are perhaps 300-400 decent companies on AIM which are being tainted by association with all the grotty stuff. Action is long overdue, and personally I would like to see root and branch reform, driven by Government to sort things out, before the reputation of the London market goes completely down the drain.

There are plenty of good companies to choose from, so why do people even go near…

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TheWatchmaker

5th Dec '14

Personally, I find it useful to see the considered viewpoints of knowledgable writers, such as Paul Scott, on these companies. Yes, there's a certain amount of voyeurism and gossip mongering attached to these headline generating stocks - but it helps remind us what to avoid and what to be on the look out for.
If Paul 'bargepoles' a stock then I need to find a very convincing argument why he's wrong before I'll touch it.

LightningTiger always talks up Plus500, Paul Scott is rather wary of it. I'm somewhere in the middle but I have more faith in Paul's viewpoint when you look at his history of comments on QPP and, in time, all his fears were proved correct.

Ramridge

Sorry melody9999 - I don't agree. There is a crying need for whistle blowers for the AIM market and Paul's repeated warnings over the years has stopped many a small investor in burning pound notes.
QPP is an obvious example. There are other, British, Chinese, Israeli, etc basket cases which he has highlighted and in some cases exposed as being short of fraudulent. More power to his elbow, I say.

Hydrus

Paul for what it's worth, I have the opposite view to the poster above. I find your warnings on companies the most helpful bit. I think it's almost like a public service. Please continue!

lightningtiger

PLUS500 have had to comply with the rules for compliance & possible money laundering a few months ago and have complied with the regulations with tighter rules to apply for new business. Regarding your "appears to be attracting muppet clients", sure there will be some, but there will also be others that can see that it is free to trade and not have to pay. Take LLOYDS for example, what is the commition on say 100,000 shares lightly to be with a broker that you or anyone else uses? It is going to cost something. So given the choice of paying to trade or trade free, some people will make that choice.
The other thing that is interesting is that they already going to pay an 8% dividend in Q1 of 2015, which means that the profits must be increasing again in order to pay the dividend out. Remember their policy is to pay out half of their profits to shareholders.

It still remains in the top 3 stocks in the UK with Vector Vest and that includes small caps as well as the FTSE 100!

garbetklb

Bit of a "surprise" that Nomads are not falling over themselves to sign up Naibu? Presumably, if Naibu can't find a new Nomad, they'll just have to delist - which I'm sure they don't want to do........

shanklin100

The difficulty for people criticising PLUS on the basis of its figures lacking credibility is that PLUS has a different business model from companies such as IGG which, relative to their level, employ far more people and IMHO have a less efficient business model.

Its just like TSCO, SBRY or MRW thinking that Lidl and Aldi could not possibly provide ongoing competition to them and then belatedly realising that the latter have far more efficient business models that rip the heart out of the TSCO/SBRY/MRW customer base.

All IMHO DYOR.

Paul Scott

Hi Shanklin100,

You could be right about Plus500 (LON:PLUS). I had a good go through the figures over the summer, and I believe that the cashflow is indeed probably real. So there aren't any accounting funnies, unlike say Chinese companies (where debtors is usually the big tell, and cash may not even exist).

Also with PLUS, it's paid out decent divis, which is very positive.

Overall though, it's not one I'm comfortable with, because I suspect the growth & high level of profits may not be sustainable. So it's not for me, but it certainly is NOT a bargepole stock for me either. So not a particularly strong opinion either way, but I'm just a tad uneasy, hence am not prepared to buy it. Good luck to those who do, you may do well if the growth & high profitability are sustainable. So a stock where we can just agree to disagree.

Regards, Paul.

Hi Paul

Thank you for your reply.

As you probably guessed, I am long PLUS, but I don't see the viewpoint in your last post as at all unreasonable. Obviously I am hoping the growth will be ongoing.

Regards, Martin

Beginner

You sound like my missus Ramridge. It is far too early to be putting up the decos yet, and not the time to be saying we are already disappointed with our pressies!

Monty9

I do like the idea of a marketing campaign:

"Buy one shoe, get the other one free"

Just found out how much Hargreaves Lansdown charges for 100,000 LLoyds shares & it is still only the standard charge £11.95 + stamp duty in spite of a reasonably chunky deal. At least you are thinking about them Paul, and something positive to say.
It reminds me of a quote from Napolian Hill's book "Think & Grow Rich :-
"2% of people think, 3% of people think they think and 95% of people don't think at all"
When I first looked at PLUS about a year ago three things impressed me.
1. It was an Israeli stock, & I knew from my 700 club that some great companies like Pay Pal & Cisco started there in Israel before being bought up by the US
2. The profits were substantially increasing each year.
3. The dividend pay out was increasing in leaps & bounds.
I was also fully aware that a large number of start ups would fail.
The potential was also huge globally & still is. People are wanting to make a few bob & prepared to give it a try.
There is also an abundance of cash with the company. The IPO was just to create the name awareness. That is all now history. At least people are aware that it is there. Current valuation around £10.00 & under valued (from Vector Vest) £7.00 from the brokers & pie in the sky from Grahams Formula with Stockopedia @ £13.86 take your pick.

cig

Let's take that example, a round trip for 100k Lloyds shares at 81p costs:

- with Plus500, 0.10% (inclusive spread) on 100000 shares that's £81
- with a regular broker at <0.2% exchange spread + say £6*2 commission that's £28

If you hold the shares for say a year, you pay a funding of 3bps a day, even if the account is fully funded:
- with Plus500: £8869 (0.03%*365)
- with normal brokers: £0

Even if you like leverage, say 50% leverage, assuming a flat price, a year costs:
- with Plus500: £8869
- with IG: £2430 (base + 2.5% on 100%)
- with IB margin lending: £810 (base + 1.5% on 50%)

So much for "free" trading.

jakedog2

Brilliant column Paul, & interesting discussion on PLUS. I am very wary of forgeign owned AIM companies. However PLUS was on watchlist for months, so I took finally took the plunge when the Oct results were released. Bought 30 mins before conference call then dialled in.

Listened intently too the CEO, however his answers were evasive & lacking clarity when challenged by the analysts around the numbers.
Immeadiatly followed my instinct & dumped the stock within the hour for a 3% loss...... shortest time I ever held a share. I may well be proved wrong but what I listening too, did not sit comfortably.

So very interesting to hear the discussion around the numbers & prospects going forward etc....

Interesting, thanks for that Sig, Just goes to show you need to read the small print. Yet another way they make some money. Generally they are a trading machine where people will only trade for a short time, & if they held for too long they would soon cotton on that it was costing them.
Seeing you like figures:-
Buying LLoyds a year ago @78.2p & now 80.89p =3.43% & on 100K = £3,430 no Div less costs.
Buying PLUS a year ago @278.93p & now 552p = 97.9% & on £100K= £97,900 + Divs about £10K less costs.
Good to know you need to watch out for compound interest eating into costs. Again DYOR pays off.
Still awaiting Q4 results for PLUS which I still recon will be good. They are still getting more customers and the customer spend is increasing, we will have to wait & see.

PS The actual net dividend on 35,851 shares purchased for PLUS would have been

£8,295.82, a bit less but non the less substantial.

melody9999

Paul - thanks for your response to my earlier comment. Looking at following comments, I am clearly out of synch with other readers. As suggested I read your column every day so I guess that says it all! Have a good weekend.

Tanglands

Paul, considering your background I am surprised that you dismis the audited accounts as "audits mean nothing" if that's correct why do you also suggest that people do their own reasearch and in your excellent analysis you often quote figures from....... Audited accounts. If they are nothing what would you suggest an investor looks at to make an investment decision?

Hi Tanglands,

OK, "audits mean nothing" is over-stating it somewhat perhaps! What I mean is that management who are determined to manipulate the figures, and who are clever, can easily outwit the auditors. There are so many areas of company accounts that are subject to estimates, judgement, that it's completely normal for FDs to smooth out the normal bumps in trading, to ensure that reported figures are close to forecasts. That's a big part of the FD's job - make sure that expectations are set at a reasonable level, and then ensure that you have enough in bottom drawer accounts to smooth out any unexpected disappointments throughout the year.

How often do you see a qualified audit report? Hardly ever! Almost every listed company that goes bust, or is uncovered as a fraud, had a clean audit opinion within 12 months. What does that tell you?

There is a massive conflict of interest with auditors - they make nothing from the audit itself very often, but it opens the door to more lucrative tax, and M&A advisory work. So often they are in the pockets of management, and the audit partner will be good pals with the CEO as a result.

So overall, I think audits will generally keep good management in line, but won't stop bad management from doing bad things.

Often audit testing is laughably cursory, in my experience. Most of the work is done by trainees fresh out of Uni in the last 2 years, who haven't got a clue about running a business, and learn on the job.

So audits give some comfort, that the figure have been given the once over, but they won't come anywhere close to guaranteeing that the figures can be completely relied upon. Dishonest mgt will fiddle the figures, come what may.

That's why I think it's so important that we check the numbers, and ask ourselves, "what doesn't look right here?" - because that will often be where the bodies are buried. Debtors is key. As are intangible assets - both tend to be dumping grounds for debits that should have gone through the P&L (and hence reduced profit).

Also, the cashflow statement is key. You sometimes find odd items in there, that undermine the headline profit figure.

There are, in my view, many listed companies which are seriously over-stating their true profitability, but adjusting profits every year. Hence their shares are over-valued in many cases.

Regards, Paul.

Paul I was slightly unfair to you perhaps commenting on a slightly sweeping statement that you made. I think we agree fundamentally although approach this from different sides of the fence. It still amazes me that none of the big four have had any come back over the audits of the banks, how come? Yet I also believe there is a disconnect between investors using accounts which are "true and fair" and "materially correct" yet reading them as if they are the answer not just an answer. In statistics one is given margin for error and as I am sure you can still remember that is how a set of accounts are audited to. If investors understood this as well as a lot of the other detail and financial analysis that one needs it may help to understand why numbers in accounts can be disclosed In a given way. Discuss........ But not at this time of night. Enjoy your writing and love the way you say what you think.

6th Dec '14

Hi Tanglands,

Absolutely, I agree with everything you say.
The way I look at audited figures, is that they present A true and fair view. Not THE true & fair view.
So that already includes massive leeway.

When you also consider the reality that the UK is way more corrupt than most people realise, but that business leaders in the UK are SUBTLE about how they do fraud. So things are never overtly bogus, they are draped in layers of clever wording, etc. That is the British way!

We all know that, and we can tell from someone's body language if they are misleading us.
That's why it is so important to meet management.

I use every set of accounts as a puzzle - i.e. I assume that the figures presented to me are bogus, and it is my job to find the dead bodies! It is amazing how many accounts are full of corpses - you will find them in intangible assets, fixed assets, debtors, and WIP.

You may even find them offsetting debits into creditors. So if creditors are shrinking, when a business is growing, that means they are hiding debits in the purchase ledger! (Globo)

In my opinion.

Regards, Paul.

P.S, More than one change of auditor = a massive claxon that the figures are bogus!! The biggest red flag you can get is more than one change of auditor (Globo).

kasbahman

8th Dec '14

Hi Paul

I have been on both sides of the fence having been audited and being part of an auditing team.

The first question everyone should ask themselves is who are the auditors acting for? Shareholders of course! BUT it is the management who appoint (with shareholders approval for what it is worth), instruct, assist and pay for the audit. The auditors ensure they are re-appointed every year have to balance between their professional responsibilities and demands the fee payer.

Perhaps it is time for shareholders to have more control??

There should be enshrined in the next release/update of the Companies Act requiring a lower level of evidence for shareholders to seek damages from both management and where the audit work carried out negligently and/or fraud not properly reported. Frauds by their very nature don't happen overnight.

Of course the reality is how will this work in practice?

Finally what about the accounting reporting standards that keep changing all the time.... perhaps look at this
http://www.icaew.com/en/library/subject-gateways/auditing/knowledge-guide-to-uk-auditing-standards

It is like a moving target!
Great Work Paul. I have been reading you articles for the last 20 months being both educational and honest.

Small Cap Value Report (5 Dec 2014) - NBU, OUT, WTM

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Paul Scott

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