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Stocks
Small, undiscovered stocks to watch
John Pitt - May 08, 2008
 If small is beautiful then small-cap stocks could be just what you’re after. Far at the other end of the scale away from the popular, mega-stocks like BHP, there’s plenty of opportunity to be had. It’s just a matter of where to look.
The place not to start is over the barbeque. We’ve all been at a garden party when someone, probably someone you’ve never met before comes over and starts chatting about a small company they’ve spotted in the paper, or been told about on one of those internet chat rooms. It’s a sure fire winner, this person claims, it’s been oversold and he’s heard a big contract is in the wind.
Sounds too good to be true? Sure. Investing in small-caps can be like stepping into the line of fire. Dodge the bullets and make it to the other end, fine. But get hit and that’s goodbye the investment.
However, there can be great rewards, as long as you know where to start and, more importantly, where to seek advice - particularly now equity markets in general are so volatile.
The ASX Small Ordinaries Index has fallen 18 per cent since the market overall peaked on October 31, 2007, with the small industrial sector, which makes up 60 per cent of the index, down 26 per cent. That’s scary.
Brian Eley of the Eley Griffiths Group says a few years ago a scattergun approach would have worked just fine, because that was when the markets were rising and almost everything was headed north. Now it pays big time to be discerning. “We spend every waking hour, and many of our sleeping ones too, analysing this stuff,” he says.
And with upwards of 800 companies out there that can lead to one mighty big headache.
Yet there are definitely buying opportunities, says Andrew Livy, senior client advisor at Lonsec Private Broking. But with markets as jumpy as they are you ‘need to have the temperament to be able to withstand and absorb short-term balance sheet losses. To use a Warren Buffett analogy: if you don’t want to own a share for 10-years then don’t rent it for 10 minutes’.
And the Buffett analogy can be taken further – the legendary US investor behind Berkshire Hathaway only invests in those companies he has researched thoroughly.
To begin with, then, getting into small caps is a matter of careful selection and patient research, summarises Steve Black, portfolio manager at Pengana Emerging Companies Fund.
He prefers defensive stocks and, like Eley and Livy, thinks there are good stories to be found in the mining services area, among companies providing services to the big miners. For instance, he mentions MAC Services Group (MSL), which builds accommodation facilities for miners and has long-dated contracts locked in place, and Mineral Resources (MIN), which produces ore-crushing machinery. Both are riding on the back of the booming mining sector.
Eley at EGG prefers HFA Holdings (HFA) in the financials sector, which looks to have been well oversold in the past few months. In resources he likes Aquarius Platinum (AQP) since it is ‘a highly profitable and canny operator’. Mining services comes up trumps again, with Eley spotting Nomad Building Solutions (NOD), which like MAC provides accommodation in remote mining areas.
Livy at Lonsec is keen on resources, given the insatiable demand for minerals from the Chinese in particular. He highlights Gindalbie Metals (GBG) in iron ore exploration and copper producer Aditya Birla (ABY).
And as for those you should stay away from Eley at EGG mentions the cyclicals, such as retailers, prone to downside when the family budget starts getting tight, while Black is wary of housing, and companies with an exposure to New Zealand, whose economy is performing even worse than ours.
At all times the important thing you must remember is research material on small companies is often negligible, at other times almost impossible to come by. If you fancy taking a punt yourself by trying to stock pick then you’ll need to have plenty of time and access to real time information.
Alternatively invest in a small companies fund.
David Smythe, a director of Zenith Investment Partners, has just finished researching them and highly recommends Macquarie Australian Small Companies, Contango Small Caps and Patriot Small Companies funds.
He has also spun out the stocks most favoured by fund managers, with ten fancying Cabcharge Australia Ltd (CAB), nine sticking with IRESS (IRE) and Transfield Services (TSE) and eight managers holding Australian Worldwide Exploration (AWE). No reasons are given, but if leading managers like them so might you.
John is a former journalist for London's leading financial paper, The Financial Times.
More articles from this edition of CompareShares:
Sector Picks: Sectors to target and avoid in 2008
Resident Trader: Making money in a tough market
Property: Are tax concessions on property really worthwhile?
Stocks: Small, undiscovered stocks to watch
Companies: Qantas engineers poised to strike
Commodities: Petrol chief criticises Coles Express
Companies: Sims reports record NPAT of $80.3m in Q3
Finance: Lincoln questions health of financials
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