Small Cap Value Report (1 Nov) - PURI, ESCH, INVU, MDM, OMIP

Good morning! Very little news today, which is handy as my mouse hand has turned into something resembling a claw, so a 2-day rest from using the computer is badly needed!

Director buying & selling of shares is not something I mention very often here. Broadly speaking I tend to ignore small Director buying & selling. Small, orchestrated buying of shares by several Directors at the same time is actually a bearish sign in my opinion - as it is usually little more than a cynical attempt to prop up a falling share price.

The Director transactions I really focus on are large ones - regulars will remember that I was bearish on Cupid (LON:CUP)  when it started to fall heavily, one of the reasons being the huge Directors selling of shares, which was an obvious warning sign that all was not well. On the other hand, a Director selling a medium number of shares, but retaining the majority of their holding, is usually acceptable, providing there is up-to-date evidence of positive trading. However, it is a warning sign, being a reminder that the valuation might be getting high, and/or that there might be trading headwinds approaching.

The flipside of this is that when I see big Director buying, I really sit up and take notice. That's one of the biggest bull signals you can get. What is big? Well, certainly into £6-figures is a Director sending out a serious buy signal. That has just happened at a share where I hold, PuriCore (LON:PURI). A Non-Exec there, Daniel Hegglin, has just bought a million shares at 45p, so a £450k vote of confidence. That takes his holding up to 4.9m shares, 9.79% of the company, so he is clearly a wealthy man, and wealthy people are usually pretty shrewd, so I am encouraged by this signal, and might follow suit and top up my position.

 

 

 

 

We're looking at a fairly strong start, with the FTSE 100 Futures up 28 points at 6,758. How long can this carry on, is the question on everyone's lips. The consensus seems to be that for as long as near-zero interest rates continue, then shares remain an attractive asset class. It's very hard to find value in smaller caps now, although there are still several dozen small caps that do fit my value criteria, but that number is shrinking gradually as they are re-rated. However, oppotunities continue to pop up, from positive trading statements, broker upgrades, etc. However I don't think there is any general opportunity in the market as a whole any more, so very much a stock-pickers market. If anything it's (selectively) some larger caps where opportunities might now lie. It is striking that both BP and Shell offer well-covered dividend yields of around 5% for example.

The key aspect of my strategy is to be prepared for a downturn. I cannot remember such a sustained period of bullishness since the late 1990s as we've seen in the last 18 months (for small to mid caps anyway), and of course that all ended in tears. Although casting my mind back, the people who suffered the most in the bear market of 2000-2002 were people who had overpaid for growth stocks - that was the bursting of the TMT bubble. People who had stuck with Value shares (which were totally bombed out by late 1999) actually did very well.

The depth of the bear market in 2001-2002 was when I personally made my best ever percentage returns - my small portfolio 16-bagged in 2 years, as there were so many amazing value opportnities to be had, and that gave me just about enough capital to leave my job and become a full time investor. Then I absolutely cleaned up in the bull market of 2003, and 8-bagged my portfolio again in 2003, to cross the 7-figure threshold, which was nice. It all went badly wrong in 2007-8, since hubris had set in, and I made some terrible mistakes of using too much gearing, in illiquid stocks, with over-sized positions. So some serious lessons, learned the hard way. I won't be repeating those mistakes ever again, and that's the reason I now take such a careful and methodical approach. When you're forced to downsize from a 5-bed detached on half an acre, to a 2-bed basement flat, you do a lot of thinking.

Anyway, so the point is that in this frothy market, I want to balance up grabbing some more exciting opportunities, but also keep some cash held back for grabbing the bargains when the correction inevitably occurs. Furthermore, value & GARP shares tend to drop the least in a correction anyway, so a (say) 10% portfolio drop is not something that should worry long-term investors.

I don't see anything likely to tip us into a full-blown bear market, although the Eurozone issue still concerns me - France and Italy being the biggest worry. Their profligate State spending habits simply are not compatible with a hard currency, so a collapse of the Euro is still a real possibility in my view, at some point a year or two down the line, if economic recovery has not saved the day.

 

 

 

 

Escher Group (LON:ESCH) has warned on profit, due to a significant contract having slipped from Q4 of this year into the first half of 2014. It doesn't sound too bad, as the software (for postal services worldwide) has been delivered, but the client will not have deployed it in enough workstations to trigger the licence payment by Escher's year-end. So on the fact of it that seems to only be a timing issue.

However, it emphasises just how lumpy Escher's sales & profits are, since they are still heavily dependent on licence revenue, although there is also some recurring revenue. It was this lumpiness, combined with difficulty in valuing the business, which was what put me off buying shares in it, despite being impressed with management and what they have achieved in becoming the dominant global supplier of postal service software, when they presented at an investor evening earlier this year, which I attended.

Their shares are down about 10% to 258p. This miss looks like it could wipe out pretty much all this year's profits, if forecasts included it. So I cannot see the share price recovering any time soon, and it's too hard to value. I don't see value here, so will move on.

 

 

 

 

One of the reasons I rarely invest in the very smallest microcaps (by which I mean sub-£5m market cap), is that the cost of maintaining a Listing (which is typically £150k+) cannot possibly be economic once you get down to that size. The trouble is, when they announce an intention to de-List, then the share price typically halves, as not many people tend to want to own shares in an Unlisted company.

This is a massive risk factor, that I often warn readers about. So when looking at micro caps, it's essential to consider whether the company has enough profits & cash to maintain its Listing, and whether the major shareholders want it to remain Listed. Also, I will pick up the phone and speak to the CEO, and ask him directly if the company is committed to remaining Listed. Of course they will always say yes, but it's how they say it that gives you the clues as to whether they are being truthful, or lying to you!

Invu (LON:INVU) is the latest micro cap to announce its intention to de-List, and the shares are down 42% to 0.35p. De-Listing requires a 75% yes vote at a General Meeting. In this case the market cap is now only about £0.6m, so it's daft such a tiny company being Listed. Although I note that the shareholder register is very fragmented, so they might struggle to get a 75% yes vote.

So please do be careful with these micro caps. They can deliver spectacular upside, but once you get down to market caps below £5m, there is a big risk of a de-Listing, which will be very harmful to your wealth.

 

 

 

 

The trading statement today from MDM Engineering (LON:MDM) looks interesting. It states that following the half year end of 30 Sep 2013, the company expects full year results (year to 31 Mar 2014) to be in line with market expectations.

This company is an engineer to the mining sector, where capex has been reduced greatly in some cases, due to the fall in the price of metals such as Gold. So it's interesting that MDM are still trading well, since the shares are priced quite low, presumably on market fears that trading is likely to deteriorate.

Market consensus is for 17.5p EPS this year, so at 153p that puts them on an attractive value multiple of only 8.7. Also, they pay out half post-tax earnings in dividends, so with a low PER comes an attractive dividend yield of about 5.8%.

Also, I've checked their Balance Sheet, and it looks very good - with plenty of net cash. So providing this level of earnings can be maintained, then the shares are good value. However, if they are working through contracts that are not likely to be replaced, then it could become a value trap if future earnings drop considerably. I don't know which is the case, but am suggesting that is the crux of the matter when researching this company.

 

 

 

 

Finally, there is a good trading statement from One Media IP (LON:OMIP). I saw this company present to investors earlier this year, and found their business model intriguing, and almost (but didn't) buy some shares. They buy up  outdated music and video, and then develop income streams from licensing it online. It's a small, but profitable niche, although clearly the company will need to do repeated fundraisings in order to grow significantly.

Broker consensus on Stockopedia is shown as 0.6p for this year, and 0.86p for next year, so that puts them on a pretty racy PER of 28 times 2012/13, and 19.8 times 2013/14 forecasts. I think that's way too high, so to my mind the doubling in share price in the last month looks pretty spurious, and is probably more down to bull market speculative frenzy than fundamentals.

 

 

 

Jolly good, that's all done for the day and the week.

Thank you to the many readers who have contributed to some fascinating & lively debate this week in the comments section below - please keep the comments coming, and I very much encourage readers to throw in your own opinions & experiences. The more interactive, the better. It's easy to register for free, there is a free option tucked away on the Plans page, which will enable you to comment. When registering, real names are preferred, but not obligatory.

Have a good weekend & see you back here on Monday morning.

Regards, Paul.

(of the companies mentioned today, Paul has a long position in PURI, and no short positions)