Small Cap Report (7 May) - QPP, SNX, CAP, KBC

Pre 8 a.m. comments

Good morning! It looks as if small cap Directors spent the weekend enjoying the sunshine, as there are very few results or trading announcements from them today.

Synectics (LON:SNX) announce a major contract win with Stagecoach. Although I'm wondering whether they have got the balance right in announcing frequent contract wins, when in this case £5m over three years doesn't sound material to their results?

 

Although it's now a mid-cap, I cannot hold back on commenting on results from Quindell Portfolio (LON:QPP).

On the surface they look amazing - turnover has risen from £13.7m to £137.6m. The profit margin looks incredibly high, as in not credible. However, the biggest red flag by far is that Debtors has risen from £31.7m to £202.3m! That's not a typo. The increase in Debtors is higher than the entire year's turnover! So that surely means that all the sales & profits booked for the year have not actually resulted in a single penny in cash being collected from those sales?

I'm almost blinded by the red flags jumping out at me from both the figures & the commentary. It reminds me very much of one of my worst investing mistakes a few years ago, Accident Exchange - which operated in the same area as Quindell, supplying replacement vehicles to people who have had accidents & then trying to reclaim the money from their insurance company.

They load up the pricing, which generates huge paper profits, and then haggle with insurance companies over payment, which results in a debtor book just getting longer & longer, before eventually there are huge discounted settlements, a large chunk of debtors is written off, the shares collapse, and a rescue refinancing is needed.

Quindell might be different, but the key figure to watch is debtors, and as I expected, this has ballooned to a clearly excessive level with QPP, so the big warning sign from similar companies in this sector whose shares eventually collapsed to virtually zero, is there - loud & clear.

I will never again invest in any company which cannot keep a tight control on its debtors. A large & growing debtor book is almost always a precursor to serious problems. That's the same reason I never invest in any Chinese companies, as they don't collect in the cash - because arguably the whole Chinese economy is a gigantic game of pass the parcel, but where everyone has been told that the music will never stop - so nobody worries about holding the parcel. The "parcel" being  bad debts of course, which are never recognised. Eventually the music will stop, and there will be the most almighty crash, we just don't know when.

 

Post 8 a.m. comments

Apparently Clean Air Power (LON:CAP) was tipped in a share newsletter over the weekend, which explains the flurry of buys and the price being up 13% this morning. As regulars might recall, this is my main blue sky/GARP pick. It's speculative, but the price seems pretty reasonable considering the potential growth from USA sales when they launch there is 2014. Their product allows HGV diesel engines to run mainly on natural gas, which of course is now very cheap in the USA.

My observation is that there seems to be a wave of new investors coming into the small companies investing space, and that generally new investors tend to go for story stocks, rather than value - because they want excitement & quick gains. In a bull market there can be rich pickings in this area, although eventually most companies disappoint. Hence why I've adjusted my investing focus a bit to look for more GARP opportunities, as well as value shares.

It's worth bearing in mind too that value stocks did really badly in the late '90s tech boom. Of course that presented some spectacular bargains when the TMT frenzy was at its peak, but the point I'm making is that when the market is looking for growth stories, then value shares can just languish for a very long time, so they're not necessarily good things to be in during a bull market, unless they pay a good dividend.

 

Another share in my personal portfolio which has been tipped over the weekend, and has risen  this morning as a result, is KBC Advanced Technologies (LON:KBC). Simon Thompson of the Investors Chronicle has done a positive write-up about the company apparently. I find that shares being tipped in magazines, online, etc, can be a double-edged thing. On the one hand it's pleasant to see the price rise, but on the other hand you know that the buying will generally be from investors with a very short time horizon, and who probably haven't done much,  if any, research of their own.

So those same investors who are chasing up the price this morning, will be a steady trickle of sellers over the next few weeks. Unless the momentum builds, and you get a continued share price rise, in which case that attracts in momentum buyers - as we've seen in the last year with many shares, once upward momentum sets in, it fuels itself.

So for more value-orientated people like us, this creates a real quandary - do well sell into rallies, or sit tight in the hope that it's the beginning of a new upward trend? For me it all depends on valuation - if the share looks fully priced, then I sell.

 

This morning has seen bizarre goings-on with the share price of Emblaze (LON:BLZ). My broker mentioned it first thing - saying that a freak trade at 15p this morning had probably triggered stop losses, and hence the shares collapsed in price at the open. I dithered, and wanted to look at the accounts first, but missed the opportunity to buy when my broker suggested (at 30p). They're now 56p. Very strange company though, which appears to be a very small, loss-making Israeli outfit, sitting on a vast cash pile. So my initial reaction to the share price collapsing was to worry that someone might have run off with the cash?

Anyway, it convinces me more than ever that putting in automated stop loss orders for individual stocks is a mug's game, if you use a CFD or Spread Betting account. All it takes is a freak trade like that to stop everyone out, and crystallise a nasty loss. That's why I never use stop losses on individual stocks.

 

So a slightly different focus today, as there were not any results of interest, so hopefully we'll have a few more tomorrow?

Regards, Paul.

(of the companies mentioned today, Paul has long positions in CAP and KBC, and no short positions)