Good morning, it's Paul here.

Apologies, for my running late today. This report will gradually emerge throughout the afternoon.

Falling knives

Some confidence seems to be returning to the market at the moment. As alluded to in yesterday's report, this is creating some attractive buying opportunities. The general sell-off in H2 of last year seemed to take most small caps down with it, regardless of how companies are performing. In particular I'm seeing good profits being made on small caps, in 2 specific situations right now;

Potentially profitable situations

1) Shares which relentlessly drifted down last year, on low volumes of selling, for no apparent reason.

When companies like this put out a positive trading update now, there's lots of scope for share price upside, in some cases. Eagle Eye Solutions (LON:EYE) is an example of this, which I'll cover below. Also Cloudcall (LON:CALL) (in which I hold a long position) springs to mind - with a very upbeat recent CMD and positive trading update, starting to claw back some of the unjustified share price losses of H2 2018. 

2) Shares which fell heavily last year, in anticipation of poor trading, then got whacked a second time on issuing poor trading updates.

This resulted in some pretty crazy market over-reactions on the downside. Good examples of this are Superdry (LON:SDRY) and QUIZ (LON:QUIZ) (in which I have a long position) - which have both bounced about 50% from the lows on their recent profit warnings.

Therefore, I'm wondering if this might be an interesting time to look closely at (very selectively) catching some falling knives, on a profit warning?

My checklist for possible falling knife catching

1) Financially secure - so a decent balance sheet, preferably with net cash, which protects the downside.

2) Reason for the profit warning falls into the temporary, fixable problem(s) category - Zoo Digital (LON:ZOO) yesterday looked like an example of a one-off profit warning, and I note it's started rising today.

3) Share price has already fallen a lot in 2018, and has a further, deep drop on the profit warning - so an over-sold situation.


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