Small Cap Value Report (Thu 28 Dec 2017) - Part 1 - reader comments only

Wednesday, Dec 27 2017 by

Hi, Paul here. Usual placeholder article for the morning.

Sorry, I messed up, and forgot about this placeholder article. So I've written a new article here (now called Part 2).

Sorry about that. I won't be adding any content here, but will leave this in place, as readers have added comments.

Regards, Paul.

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26 Comments on this Article show/hide all

ken mitchell 28th Dec '17 7 of 26

Also agree that Stockopedia information on profits warnings has been invaluable.

Not sure about your figures for a couple of the shares Carcosa.

E.g Character fell to around 380p on day of profits warning but had bounced by the end of that day, perhaps partly because of Paul Scott’s Small Company Value Report comments, and is now 445p.

Also Revolution Bars fell to 110p on day of profits warning and then doubled during the bid events and is now 152p.

There has also been a big bounce in Provident Financial share price since 70% fall on day of their warning.

Also the nature of the warning is important. If looking like temporary easily soluble blip then fall on profits warning can be good buying opportunity. That’s where I find Paul and Graham’s comments invaluable. E.g Paul pointed out that RBG share price fall left them very vulnerable to a bid.

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Carcosa 28th Dec '17 8 of 26

In reply to post #289943

Thanks Ken,

The shares I tracked were at prices at the practicable day I could record them; not at the closing price. Some may have been a few days after the profit warning was issued and others a few hours after the warning was issued.

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fwyburd 28th Dec '17 9 of 26

Re: Selling after profit warnings
The general rule of getting out quickly has worked well for me (after I read the Stockopedia report and Minervini's book).
However there are exceptions to the rule, GAME Digital (LON:GMD) being a particularly notable example. Graham's report on GMD was very insightful about their short leases and he (or Paul?) designated it a special situation stock. It triple bagged within a few months...

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jonthetourist 28th Dec '17 10 of 26

In reply to post #289898

I think there is one type of profit warning that potentially throws up opportunity. There may be others, but this is the one I look out for.

Being a director of an unlisted business is pretty straightforward. You devote your best efforts to making the company a success, and from time to time your finance director tells you the score. Once listed, a large part of your efforts have to go into ensuring that progress is consistent and uninterrupted, even if it is a lot slower. Your finance director is not so much counting your results as telling you what the score needs to be. This can be a huge culture shock, and sometimes the realities of the change are only communicated by the first profit warning.

An example was Endace, a university spin-off selling an innovative defense mechanism you plugged into your network to prevent malicious attacks. In their first year post listing, they released the news that their chip supplier in China had had a failure of their production line and the company needed to switch suppliers, leading to missing their first-year profit target. It felt like an irritation to management, but a disaster to the market, leading to a 50+% price fall. I spent half a day googling, and decided the directors were naive rather than crooked, leading me to load up on the shares. It turned out to be their only profit warning, and they sold out a couple of years later for around 5 times the marked-down price.

So moral of the story to me is profit warnings are a bit like defending a corner (apologies to non-football fans). It is a high-risk situation where you need to be very alert to danger, but there might just be an opportunity to break up the pitch and score, while all the focus is on your goal.

Seasons Greetings to Paul, Graham, and all SCVR contributors.


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rhomboid1 28th Dec '17 11 of 26

Morning Paul
Eservglobal (LON:ESG) slipped out this Which linked to this, which shows a rather worrying picture, I don’t hold but recall some interest around it..

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Ron1302 28th Dec '17 12 of 26

Hi Paul, are you doing a NAPS2018? or did I miss it?

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Benson 28th Dec '17 13 of 26

In reply to post #289898

Sounds like you have developed a good shorting stratagy!

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herbie47 28th Dec '17 14 of 26

In reply to post #289898

Somero Enterprises Inc (LON:SOM) profit warning, when was that?

Yes small sample I can think of a few that went up after a profit warning, Boohoo.Com (LON:BOO) from 22p to 265p, Renishaw (LON:RSW) about 1800p to 5500p, Pendragon (LON:PDG) 22p to 28p, Provident Financial (LON:PFG) 590p to 918p and Revolution Bars (LON:RBG), GAME Digital (LON:GMD) as already mentioned. Of course 1 Boohoo.Com (LON:BOO) would take out all your losses. I don't think it's as clear cut as some suggest but I do tend to sell on bad news these days.

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emmettsmith 28th Dec '17 15 of 26

Hi Paul

You have identified some fascinating stock picks for 2018. Out of the 5, only RBG has a good Stockrank. Is the Stockrank missing something? Or are you identifying stocks ahead of a good ranking in the future?

Kind Regards

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peterg 28th Dec '17 16 of 26

I'm quite sure profit warnings need to be taken seriously, and I do, and in many case that means selling or staying clear.

However, to take an entirely non statistically significant sample I have bought twice this year after profit warnings - RBG, sold at a profit, and PFG holding on a paper profit.

I don't claim great skill here, luck is clearly the most important factor in most of all our investment decisions, but in both cases there were reasons why I didn't agree with the view that a profit warning is a profit warning so run a mile. And this time at least it's paid off. I also bought SOM, also on the profit warning "list", though I don't remember one - and so far I'm about break even, so the least successful so far of the three!


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FREng 28th Dec '17 17 of 26

Readers may not have noticed that there is a genuine SCVR for today now, in parallel with this placeholder

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paraic84 28th Dec '17 18 of 26

It would be interesting if Stockopedia could also do an analysis of the opposite of a profit warning: i.e. a company reporting better than expected profits e.g. perhaps in a turnaround situation. It'd be interesting to see if the share price rises are of a similar proportion to the share price falls for profit warnings over say 6-12 months. Or perhaps people are quicker to buy on good news, thus leaving less potential share price growth, than to sell something they're attached to on bad news?

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herbie47 28th Dec '17 19 of 26

In reply to post #290093

Well there are guru screens that are similar to that, ie Earnings upgrade and Earnings Surprise screens.

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bestace 28th Dec '17 20 of 26

In reply to post #289898

when you own the share in question it is difficult for many investors to do such a dispassionate analysis for it to be meaningful.

This is where a checklist can come in handy both as a means of helping to remove the emotion from the analysis, and helping to ascertain whether the profit warning is 'merely' a failure against market expectations or a failure of the business model as a whole. For me, a blanket policy of always selling on a profit warning is too prescriptive.

A useful framework I came across earlier in the year was from the book "Capital Account" by Edward Chancellor, which included the following table. This relates to turnarounds rather than to profit warnings specifically, but there is obviously some overlap:

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ken lowes 28th Dec '17 21 of 26

I keep a portfolio of everything that I have sold for whatever reason. This year amounts to 40 positions sold, the result is an extra 1% profit if I had held them.. Putting that into context virtually every indecies is at a high how big do you think the loss would be if the market wasn't at a high? 22 positions are positive and 18 are negative. Of the winners Genel Energy (LON:GENL) was top with 78.4% gain since sold, Games Workshop (LON:GAW) 61%, Wizz Air Holdings (LON:WIZZ) 53%, Cranswick (LON:CWK) 29% and WH Smith (LON:SMWH) 29%. The bottom 5 were Applied Graphene Materials (LON:AGM) sold as a result of the RisK Analysis where it was given a Sucker Stock status, I came out with a 50% plus profit, so wasn't I lucky, conversely I bought Utilitywise (LON:UTW) the day prior to an announcment, took the 17% profit warning fall and sold immediatly, currently down a further 64%, Gem Diamonds (LON:GEMD) down 34%, ITV down 20.7%, bought as a result of a well thought out analysis on this site and Galliford Try (LON:GFRD) down 19.1%. the rest are somewhere between the top and bottom five. Everything is easy with hindsight but personally if the rule is sell on a profit warning then it must be better to sell, otherwise why have the rule. if it was easy to pick the recovery stock then why would all those with far more experience than most of us "tell us to sell". Up until a month ago the losses were greater than the gains but then I crystalised my Gold holdings because the rule said I should and the very next day the gold price turned up along with the Mining ETF's, of course I am cursing but in my opinion there is no place for trying to second guess what the price action is doing. The rules are tried and tested and it appears that overall they are working otherwise I would only be 1% better off and have a huge exposure to the market. Minervini is a bit of a hero but can some one tell me " how do you get to a 10% loss when keeping loses to around 3%? In some respects keeping my losses down has cost me this year so I will have to revisit that rule!

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gus 1065 28th Dec '17 22 of 26

In reply to post #290168

Hi Ken.

Not sure if the context of your last comment, but if you hit a losing streak of several small losses on individual stocks the cumulative effect on the overall portfolio can be a higher overall aggregate loss.

For example, if you start with £100 and Invest it in a stock that drops 3% then reinvest the balance (£97) in another stock and lose another 3% you’re now down to about £94 and change. Another couple of churns with 3% losses and your portfolio is now worth less than £90 representing a more than 10% loss on your original capital even if your worst loss on a single position is never more than 3%. Add in transaction costs and bid offer spread and your net capital is even lower.

Some of the successful traders like Minervini and Robbie Burns might accept this kind of attrition with more losers than winners (for example in a falling market) provided they make significantly more from their overall individual positions when running their winners than a larger number of small/stopped losers.


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herbie47 28th Dec '17 23 of 26

In reply to post #290168

Not sure where the 3% loss comes from? Believe Minervini uses a 8% stop loss of course that is not guaranteed, if there is a bad profit warning you could lose 30% or more. Minervini trades US stocks many of which would be in the FTSE100 if listed in UK, so it's probably a bit different from trading small to mid UK caps. I found 10% stop loss too tight for UK small caps. You also may have quite wide spread on some and trading costs.

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ken lowes 29th Dec '17 24 of 26

In reply to post #290228

Hi Gus
I agree with all that you have said regarding the level of losses. As you know my experience comes from that of long term investing and the analysis of collectives to achieve a greater long-term profit. Only in the last three years have I started to get heavily involved with shares of any kind, my previous experience was usually a disaster as a result of guesswork and story stocks which cost me greatly in comparison to the safer world of collectives. Since our first conversation two years ago I have spent many hours trying to devise my own set of rules. What I have found regarding stop losses is that they are both necessary and dangerous. As soon as a discussion on stop losses appears on this site someone will describe how the stop loss was taken out unnecessarily. It has happened to me where a stray downward spike appears which can be seen during the trading day but disappears from the history of the price action. My most recent occurred in a gold mining investment trust, fortunately I only found out when my broker apologised for missing it, as it was about 8% lower than the current price I wasn’t unhappy. Clearly volatility is a curse and Minervini suggest that one should stay away from volatile shares, so that is probably most of the shares already invested in by those who profess to be followers of Minervini. My reading of Minervini and the back testing, live testing and creation of many fantasy portfolio’s that I have carried out over the last nine months tells me that the Minervini Story is one of a many ambiguities and trading examples of contradictory suggestions. I still believe the overall advise is valuable but his advice on stop losses is far from clear. I read recently that successful trading, which as we both know Gus is different from long term investing, is 20% What to Buy, 10% How to Buy, 30% When to Buy and 40% When to Sell. I don’t think I can disagree with those statements. I am concluding that each share has its own natural rhythm and within that rhythm is the ideal place for a stop depending upon the expected duration of the holding period. Obviously, risk management must come into play so if the stop loss is outside of the comfort zone then perhaps the trade should be discarded. My current thinking is that a guaranteed disaster stop should be in play, say at a trailing 20% plus, additionally a manual trailing stop set at an average true range ( ATR) of 2. When the ATR is pierced it is only a sell if there is a clear break of the ATR support followed by a negative day. Which means selling after two or more days after the clear break, which can still be costly. If the break is false, then the price action will return upwards. The alternative is as you say a series of false stop losses that erode the portfolio value in the hope of getting a big break. Prosperous 2018 Gus.

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ken lowes 29th Dec '17 25 of 26

In reply to post #290273

Hi Herbie
See above, I think you are right about the difference between where we play and the market Minervini is in, hence the difference in our understanding of what he is trying to achieve.

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ed_miller 2nd Jan 26 of 26

In reply to post #289898

Your 'Profit Warning' portfolio is well worthwhile, though it will track a quoted mid-price that for many illiquid shares at the time of profit warnings is a notional price much better than an actual available selling price.

For such an illiquid share, when faced with a profit warning, if one can reasonably conclude that the setback is fixable and temporary, one might thus avoid locking in a loss, perhaps a large one (or else a much-reduced profit). In these circumstances, holders must try to be dispassionate: is the problem due to a delay on a contract for which there is high confidence the contract will land? (Care is needed: CEOs are salesmen and at least as prone to wishful thinking as the average holder of a company that has just announced a profit warning.) Or is it - like the established supermarket groups facing disruptive competition from the discounters - due to a structural decline, for instance?

I'm not trying to change your settled view - one that you've found has improved your performance - nor deny the usefulness of the Stockopedia research on profit warnings, but I am pointing out that the scope to avoid a continued slide in share price for a period of 6 months to 2 years can be absent for very illiquid shares on the day they are hit by significant profit warnings, since the selling prices available are straightaway so very dramatically reduced, and for such shares a more discerning and flexible stance might actually be the best strategy. Having said this, I agree that the Stockopedia analysis shows that if after a profit warning, one can get out of a share before a big drop in its price, then that is the best strategy; similarly, one is usually best waiting at least six months (and sometimes up to two years) after a profit warning before 'buying the dip.'

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About Paul Scott

Paul Scott

I trained as an accountant with a Top 5 firm, but that was so boring that I spent too much time in the 1990s being a disco bunny, and busting moves on the dancefloor, and chilling out with mates back at either my house or theirs, and having a lot of fun!Then spent 8 years as FD for a ladieswear retail chain called "Pilot", leaving on great terms in 2002 - having been a key player in growing the business 10 fold. If the truth be told, I partied pretty hard at the weekends too, so bank reconciliations on Monday mornings were more luck than judgement!! But they were always correct.I got bored with that and decided to become a professional small caps investor in 2002. I made millions, but got too cocky, and lost the lot in 2008, due to excessive gearing. A miserable, wilderness period occurred from 2008-2012.Since then, the sun has begun to shine again! I am now utterly briliant again, and immerse myself in small caps, and am a walking encyclopedia on the subject. I love writing a daily report for on most weekday mornings, constantly researching daily results & trading updates for small caps. Cheese! more »


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