‘Investors can’t consistently outperform the market’.
That’s what academic theory says.
But it’s not true. And I’m going to show you why you can beat the market. All you need is a little know-how.
Not all markets are efficient
The theory says that financial markets are efficient. The central assumption is that any news, like BP reporting an oil find, will show up in the share price immediately. In this case, the price of BP (ticker: BP) shares should go up to reflect anticipated profits from the new find.
It seems reasonable enough. Analysts and traders are constantly scouring the news feeds, reacting to news as it hits their terminals. And investment banks’ computers constantly monitor markets, picking up on the slightest anomalies in prices…
So if something appears to be underpriced, it’s bought, helping to push the price up until it’s ‘right’.
In other words, there’s no chance for any one investor to consistently get in on a stock before the news is already in the price.
BUT, in the smaller company universe, the theory doesn’t work quite as effectively. (That’s why most of the academic studies focus on the large caps!)
There are two major problems… or actually, I should say, opportunities…
Why the professionals steer clear of small cap stocks
First, fund managers deal with massive investment funds, often in the billions. They’ll put tens of millions into any one stock. If they wanted to buy into a small company, the price would soar before they even registered the first £100k purchase. When they come to selling, the price tanks for the same reason. This is a liquidity problem.
The upshot? Fund managers don’t buy small cap stocks.
Secondly, there’s an information problem….
Companies on the stock exchange are often as small as £10 - £50 million capitalisation. It’s simply not worthwhile for an investment bank to pay an analyst to follow these tiny companies.
Without the large investment funds, there aren’t enough commissions to fund any analysis of these tiddlers.
All of this means that among the small caps, there aren’t many professional traders about. Information is poor and can be slow to filter into prices.
Put simply, the market isn’t ‘efficient’.
This is great news for private investors. Providing you know what you’re doing, you really do have the opportunity to beat the market.
Make the most of an inefficient market
I did mention a very important caveat: ‘Providing you know what you’re doing’.
The fact that the market is inefficient means that there are opportunities for finding an under-valued stock. But importantly, there are pitfalls too, stocks can also be over-valued. An inefficient market doesn’t mean easy profits just for the taking.
The key to unlocking the potential of this market is to take the principles of investment used by the professionals in the large caps and apply them to small caps.
That means analysis. Really understanding what the business is about. Understanding the industry in which it operates. Assessing the management – deciding whether these guys are worth investing in. Most importantly, it means assessing the figures. Do the accounts stack up? Is this a sound business that’s going to deliver sustainable returns?
OK, that sounds like a lot… and it is! But I know a man who does exactly that. He loves small cap shares. He has a lifetime's experience of analysing them. And – most importantly - he loves to share his discoveries with private investors.
Let me introduce you to my colleague, Tom Bulford. Tom left the City to focus on his own investments. He uses his investment knowledge to find and appraise undervalued, small companies.
If Tom hasn’t got his head in a set of accounts, he’s usually out talking to the management of the companies he’s interested in. This is exactly what the City analysts do all the time. The only difference is that in Tom’s niche, he’s pretty much out there on his own. And he publishes what he finds his newsletter, Red Hot Penny Shares.
It’s not a free service, but it’s not far off, given the amount of research that he does. And Tom does a great job of coming up with undiscovered companies with huge potential.
If you’d like to enter the small cap market, I really recommend you check out Tom’s advice and share tips. Just click here.
Good investing…
Bengt Saelensminde
For The Right Side
P.S. On Monday, I’ll show you a small cap company that’s been missed by the City. It’s in an excellent area of the market, it’s making good money, it’s cheap and its got a great balance sheet.
Red Hot Penny Shares is a regulated product issued by Fleet Street Publications ltd. Forecasts are not a reliable indicator of future results. Commissions, fees and other charges can reduce returns from investments. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you’ve bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3600.
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