Investing in the small and micro-cap sector is exciting but can be volatile at times. More important than the actual volatility is how we react to it. Keeping cool during price fluctuations often pays off, because today’s price falls could become buying opportunities which drive tomorrow’s returns.
This reporting season has been no different, with a fairly even split between good and bad results so far.
Here are some things we keep coming back to at Prime Value, which allow us to keep cool when the market might be losing its head:
1-Focus on the business: results are easier to process when you understand short and long term expectations and what drives them. Key issues to keep focus on the business include:
- Know expectations – understand market expectations both in the short term (current result being reported) and the longer term so you can quickly judge performance.
- Understand the key drivers of the business – most companies have a few key points of earnings leverage. By knowing where to look you can quickly assess changes that will affect outlook.
- Overlay this information with the management – look for quality management and understand their strategic priorities and alignment.
2-Meet and ask questions: truly understanding key issues in a small or micro-cap business is only possible by meeting and asking questions. We endeavour to truly understand the companies in which we invest and will have hundreds of meetings every year looking for new opportunities. When meeting a business we often pick up unexpected things. We may even pick up some interesting information about other companies.
We love finding companies that are not well known by the market or undergoing change that may take other investors time to understand – this might be the industry or the company itself. We think experience and a willingness to talk to industry experts enhances our ability to take advantage of these opportunities.
3-Understand the turning points: we’re always looking for turning points in a company or sector – this is not about short-term price signals. We are not traders – we prefer to buy and hold, and reap the rewards of compounding returns over time. Turning points refer to larger changes in a company’s strategy or industry.
As a recent example, consider Cogstate: they recently prioritised profitability and a focus on their core operations. By ceasing investment in a long term, uncertain venture they exposed the underlying profitability of the core business. Having followed the company for many years we understand the core business and were ready to act quickly to build our position.
The market appears to be coming to a similar view and the stock is now rising. We think it has further to go. By understanding turning points and drawing from our corporate memory, we can quickly react to opportunities that are presented.
Richard Ivers is portfolio manager of the Prime Value Emerging Opportunities Fund – Class A