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How to Identify Small Cap Performers

Many retail investors have the misconception that small caps are risky shares. Thus, they might prefer to stick with shares with big market capitalisations in exchange for a peace of mind.

In fact, it reminds me of the words of my father: “Even though they [the big caps] might not appreciate in value as quickly compared to small cap companies, they would not disappear [get suspended from trading] within a day!“.

While his statement comes with a tinge of bias against small caps, suspended stocks like China Hongxing Sports (SGX: BR9) does lend weight to this words. Nevertheless, mid cap and large cap companies  do not appear from nowhere and those companies were probably small cap shares themselves many years ago. Thus, the trick actually lies in spotting the common characteristics that top performers share.

Some examples I have cherry picked due to their astonishing share price appreciation over the past 2 years include Riverstone Holdings (SGX: AP4), Silverlake axis (SGX: 5CP), Oxley Holdings (SGX: 5UX), and Sino Grandness (SGX: JS5). Out of these shares, I found 2 yardsticks that are common.

Company

14 Jan 2012

11 Jan 2014

% Change

Riverstone Holdings

S$0.405

S$0.745

84%

Silverlake Axis

S$0.32

S$0.915

186%

Oxley Holdings

S$0.178

S$0.575

223%

Sino Grandness

S$0.203

S$0.755

273%

Source: S&P Capital IQ

Strong Sales and Earnings growth

It is not uncommon for small cap companies to prefer retaining cash for growth opportunities rather than returning it to the shareholders as dividends. As a result, they often grow much faster as compared to larger, more mature peers.

A great example would be American consumer electronics giant Apple. After people got used to its exciting line of Macbooks and iPhones, it has since hit a peak where growth would likely be considerably slower. Tim Cook, chief executive of Apple, has also been honest about it and hence, the company has been returning more cash to shareholders in the form of dividends and share buybacks since 2012.

So, to separate the wheat from the chaff, investors usually look for higher than average earnings growth in small companies. Take for example, Silverlake Axis, a leading provider of end-to-end universal integrated banking solutions to major financial institutions. Its earnings per share has soared from a record low of 3.04 RM sen just after the financial crisis to 9.25 sen in year 2013 – an annualised growth rate of 51.07%!

As for rubber glove maker Riverstone Holdings, its revenue and net profit had grown at impressive compounded annualised growth rates of 21.7% and 12.9% respectively from 2008 to 2012. On top of that, it is debt-free and has also managed to provide increasing dividends over the years.

Substantial Positive Impact in the future

Apart from increasing profits, a stream of beneficial news is also a common theme among top performers. Such news can help renew investor sentiment in the company, highlight its improving fundamentals, and help push its share price to greater heights over the long run. For instance, over the past year, Oxley Holdings has been active in the limelight by announcing real estate acquisitions in the prime areas of London, England and Kuala Lumpur, Malaysia, among others.

It’s the same with food producer Sino Grandness. On top of consistent improvements in its earnings, the company has had several upbeat developments which have generated a fair bit of interest among investors. It has continuously secured new distributors and distribution channels and won more orders from trade fairs. The recent shareholder purchases coupled with the upcoming Garden Fresh initial public offering has also helped bolster confidence in the company.

Foolish Bottomline

Even though the share price of small cap companies can often rise very quickly tandem with increasing earnings and good prospects, it may turn ugly all of a sudden too. One such example is Ausgroup (SGX: 5GJ). Once a market darling in 2012 when it skyrocketed from $0.35 to $0.65 in a matter of 6 months, it has since plummeted all the way down to $0.178 in recent times due to poor market conditions.

So, as useful as the two yardsticks are, one cannot just depend solely on them to find winning shares. More importantly, an investor should be comfortable with what he/she is investing in and perform the due diligence needed. That’s especially so when our own hard-earned money is at stake.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor James Yeo owns shares in Sino Grandness.