UNDER THE RADAR'S
SMALL CAP PORTFOLIO STRATEGY
"The Idle Speculator" is our independent portfolio manager. He has a strong record of 20% returns a year over 20 years. He has set up a paper portfolio to show you how to set up and manage a diversified small cap share portfolio. He gives regular updates.
Set Up Your Portfolio
It's important to firstly get the structure of your share portfolio right. Essentially half your portfolio should be invested directly in blue chips or in market based investments. Up to 25% should be in cash so you are always liquid to take advantage of buying opportunities and 25% of every portfolio should be invested in 7-10 small caps to give your portfolio the opportunity to really grow.
Our job is to find small cap shares that we believe will give your portfolio a boost. We give you opportunities to buy stocks each week but which ones should you actually dip into and buy?
Under the Radar Report's portfolio: What do we look for?
One of our analysts used to be a gaming analyst, rating companies that operated casinos, poker machines and wagering businesses. It became clear that no matter how good the management was, it didn't make a difference. Anti-smoking laws and a general crackdown via increased regulation by the state of gambling meant that the profits of the whole industry were contracting. It is always good to have a top down view of things.
Cash is king
In the financial crisis it was obvious, but the rule always applies: Cash is king. No matter how rosy the investment climate may look, it is important to look at the balance sheet to see what financial engineering is going on behind a company's returns. If you are in an investment for the long term, you want to be sure that the assets the company lists can be sold and that it is producing a solid amount of cash after paying for its day to day requirements as well as those necessary to ensure its profits grow in the future. The ratios we like to look at include a company's book value (its net assets), its forecast price earnings ratio – with an emphasis on the E in PE, and the amount of interest it is forecast to pay, relative to its earnings before interest payments and tax.
In the case of mining companies and biotechs, there is a different orientation. Here we look at the cash burn rate and what the likelihood of raising capital is. Raising equity isn't the worst thing in the world, but you want to know that there are performance hurdles the company will meet in the near term that will help raise investor sentiment (meaning its share price). Also, a clear understanding of when the company will be cash flow positive and not need any more cash injections is critical.
Company's share price
The chart. Even if, like us, you are sceptical of technical analysis, the graph of a company's share price always tells an interesting story. Although the chart won't tell you how to invest for the long term, it gives the best idea of the sentiment that any given stock/sector/market has experienced over differing time frames. This is a big aid in timing your decision to jump into or out of a company and whether it is regarded overall as a consistent performer by the investment community. Those looking to delve a little further could possibly look at the beta of a company, that is, how it is correlated against the market. But I believe that the one-year and five-year charts are good enough indicators of investor sentiment.
Whether talking to management or not, it is important to gauge their performance. You need coherent explanations of past performance as well as what their plans are for the future. Management needs to both talk the talk and walk the walk.
Bull Points/Bear Points
What are the positives and negatives of the company from an investors perspective? This must be done with as much objectivity as possible.
For an investor, everything really comes down to this. Having a clear idea of what a company's valuation is makes it easier to make buy and sell decisions. Our decisions are based on simple valuation methodologies such as price earnings multiples and analysing the present day value of near-term forecast cash flows.
What will happen in the future that will lead to a stock moving towards the valuation we have chosen. Underlying this is the primacy of timing. In investing timing is important, although rarely do people get it right. We have a believe that the main thing to do is to buy and hold. Patience is one of the biggest virtues and investor can have.