Trading Expo Seminar article.pdf

8/10/2019 Trading Expo Seminar article.pdf

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I www.contango.com.au Contango IMicrocap Limited 16 July 20141

Microcap Investment

1:45pm to 2:15pmMICROCAP

Seminar

This sessionhighlightedways in which tomore successfully find the hidden gems that can be

found among the micro-cap end of the market.

1. Learnt where a fund manager specialising in them sees investment opportunities.

2. Developed a better understanding of how to value micro-cap companies

3. Leaned how to incorporate them into your portfolio, and

4. Saw some critical features to look for

DIVERSIFICATION, OPPORTUNITY AND PERFORMANCE

In mid 2014, the CBA was worth more than every ASX company outside of the

ASX200combined! Out of nearly 2,000 companies listed on the ASX the 13 largest hada market cap greater than all other ASX-listed companies.

This extreme concentration leads many investors to miss those small and microcap

opportunities which can provide diversification, opportunity and performance to their

investment portfolio.

Diversification: An allocation to microcaps can

reduce the BlueChip risk factor of being

overexposed to the top 100 stocks.

Opportunity: Microcaps can be the fastest

growing companies on the sharemarket andthere is very little research undertaken on them and

Performance: Microcap companies offer some of the best opportunities for investors

where increases in revenue can result in a great impact on profit

Generally, most sharemarket investors with a time horizon beyond 5 years could

comfortably allocate 5-15% of their total shares allocation to Microcaps. Some investors

may be surprised to discover they have that much invested in one or two large cap

stocks alone.

Microcap investment manager Contango sees an FY15 outlook of solid but not stellargrowth of around 3% as the economy transitions from mining investment to non-mining

investment and consumption. In this environment the preference is for companies with


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Microcap Investment

solid growth profiles and high free cash flow yields, while avoiding low growth

defensives and pure-yield type companies.

The small cap sector typically outperforms large caps when risk appetite is

strong. While that might not describe the current environment there are always select

opportunities particularly in well-managed, small industrial companies with strong EPS

growth prospects and solid balance sheets.

Investors may do well to remain cautious about small companies exposed to the mining

sector, particularly if they are early-stage or carrying high debt levels. In a stronger

growth environment, when bond yields and commodity prices are typically rising,

investors can look to increase their mining exposure. Until then find the right

combination of high quality companies with attractive valuations at the right point inthe business cycle.

FUNDAMENTAL MARKET VALUATIONS

From a fundamentals perspective the Contango MicroCap Limited portfolio of 69 ASX

listed microcap stocks is demonstrating

attractiveness on a both relative and

absolute basis.

DO YOUR OWN RESEARCH

With microcaps the information is

scarce and share prices volatile.

Research and

discipline are the

core of microcap investing where knowing a company, understanding

its operations and its industry are critical.

Limited information arises from brokers who cant recover the cost of

producing research on them and media covering better knowncompanies. Good stories are eventually covered but in the early stages

of a companys development, information must be sought. Herein isthe opportunity with microcaps in that disciplined investors with

clearly defined processes can find good stocks to invest in.

KNOW THE COMPANY

Fundamental and Quantitative research will never go out of style. Understanding the

constructs of and the principles behind price/ earnings, EPS growth, balance sheets and

cash flows are non-negotiable. The same with discounted cash flows- you dont have to

be able to build a DCF model, but you have to understand them. For instance, if the priceof oil goes up 20% or gold is discovered you need to be able to calculate how that will

impact share price.


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Microcap Investment

Investors also must be able to deconstruct a company. By that understand how it

operates and generates its profits, what its key advantages are, identify key risks in itsbusiness model and understand the attractiveness of the sector it operates in and its life

cycle.

At each point of the cycle investors need to have a different understanding of cash flows

and profit expectations. The market ascribes different valuations to a company and its

assets depending on where it is in the cycle. For a mining company this goes from:

Exploration Feasibility Pre-Bankable Project Construction Construction

Production.

Likewise Gold companies are not all the same and dependant on their point in their life

cycle you must factor in a different Enterprise Value and Dollar Value to pay per ounceof Resource held by the company. (ie dont pay as much for Inferred resources as youwould for Measured resources)

Similarly when determining companies Net Present Value (NPV) valuations will differ

dependent upon their point in the cycle. As such a Producer should be expected to trade

at a higher price than its NPV because it offers a greater leverage to commodity prices.

While investors often dont have the information fund managers can source there are

things they can do to better know a company which will add value to their investment

strategies. Essentially, investors who do their research can better determine what price

to pay, and best times to execute their trades.

DIY, LIC OR UNIT TRUST?

Microcaps can be accessed either directly by buying shares on the

ASX, or outsourced to a investment manager. Given sufficient time,

resources, skill and inclination most investors can create a

diversified portfolio of 20+ stocks robust enough to withstand

shocks to one or two stocks within.

However it is hard to do this continually, never mind sleep comfortably at night - as

investing in the share market carries risks and microcap companies can be extremely

volatile, where events such as an unexpected fall in revenue can have a significant

impact on the value of the company. Its no surprise that fund managers have teams of

5-10 people focussing full time on these companies.

There is no best way, or one size fits all way to invest in microcaps. One potential option

is to allocate 75% of ones micro exposure across 2 or 3 fund managers, and perhaps 5%in each of five securities well known to the investor.

In many instances investors can only access specific fund managers via an LIC, which are

increasingly popular for their dividends and franking, as well as the transparency andcontrol they offer. Some LICs focussing on small & microcap stocks include Mirabooka,

OzGrowth, WAM Capital and Contango MicroCap.


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GETTING INTO THE STOCK

When choosing stocks avoid reliance on stereotypes. Each company is unique and has aprice so dont invest in a company because of one

feature- such as it being a Rare Earths company.

Likewise dont not invest in it for the same reasons.

Look for a balance, avoid holding too many of the same

type of company and look for spread. At least 20

microcaps offers a diversified portfolio.

Know why you are investing in the company. Create a

folder for every investment you consider, build an

investment checklist and stick to it. Be rigid, disciplinedand methodical.

If you decide to invest in a stock write a paragraph detailing why you like it, why you

invested in it and at what point you will exit it. Have your trading strategies pre-

planned, relating to tactics for:

Getting set:

How will you accumulate your position? How might that impact share price?

Managing the investment:

What are your actions upon price falls and following negative or positive news? Exit Strategies:Is your eye always on the exit door? What happens as you near your target price?

SUMMARY

The sharemarket remains a medium to transfer wealth from the impatient to the patient.

There is a case to invest in Microcap companies however discipline, research and

patience is required. The lack of microcap research provides hands-on investors with the

opportunity to get ahead of the market and find quality investments at the right prices.

Microcaps can be both exhilarating and financially rewarding. Investors are remindedthat diversification is critical to ensure their portfolios are protected from those shock

events which even the best research cannot prepare for.

Astute investors who prudently allocate to MicroCap companies are well positioned to

capture the growth in these companies as they progress from micro into successful, well

known companies.

NOTE AND DISCLAIMERThis article is written as an introduction to market investing. It is NOT to be construed as providing financial advice or a statement on themarket. Microcaps are a volatile investment class and may not be suitable for your investment needs. Consult professional financial

advice before making any investment decisions.Forecasts in this article are predictive and based on numerous assumptions including

the forecast outlook for key variables and may be affected by various factors including inaccurate assumptions, risks and unforeseenevents. Accordingly, actual results may differ materially from those implied or forecasted. Contango Asset Management Limited (ABN 52085 487 421) holds an Australian Financial Services License (AFSL #237119) restricting it to providing financial products and services towholesale clients only.

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Trading Expo Seminar article.pdf