We are six trading days into August now. It hasn’t been a good start to the month.
The Dow Jones Industrial Average is down 3.49%. The S&P 500 is 3.48% lower and the NASDAQ is in the red by 2.57%.
Aussie indices haven’t been spared either.
The S&P/ASX 200 is down 2.18%. And the small cap index in Australia, the S&P/ASX Small Ordinaries, is lower by 2.40%.
Like I said, it hasn’t been a good start to the month…
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This doesn’t necessarily mean that this August will be a lousy month for Aussie stocks. But the odds are stacked against you if you want to finish in the black at the end of the month.
However, falling share prices aren’t always bad news.
Many investors can use market dips like this to pick up shares they normally would think were too expensive.
It’s important to remember that when the massive companies are dragged down by the market, the little guys tend to cop an even bigger beating.
Believe it or not, this can be good news for you.
Let me explain what I mean.
Many companies are in reporting mode. That means they’re releasing the 2014 financial year data.
As market sentiment is down, firms that don’t have great end of year reports are taking a bigger hit than they would otherwise. Many companies are finding their stocks sinking further into the red.
As a result of this, some mid-cap stocks with falling share prices are slipping into the small-cap sector.
This could present an opportunity.
Let’s take Ausdrill Limited [ASX:ASL] as an example.
At its peak in 2012, it was a $1.3 billion mining services company. Two years later, after losing service contracts, poor financial performance and write downs, it’s now a $294 million small-cap stock.
Does this make Ausdrill worth investing in? Right now, no.
Perhaps some financial prudence and growth in service contracts could see this company become worthy of investment. But because of the low share price — right now around 95 cents — it could turn out massive triple digit gains if it gets the business under control. But only if it can turn around the business.
There’s no point buying a beaten down stock just because it’s cheap. That would be silly.
However, should Ausdrill reshape the company and come up with a new way of meeting its client’s needs — and get a handle on spending — it could offer small-cap like gains.
As improbable as it sounds, this has happened before.
Take Fairfax Media Limited [ASX:FXJ] for example.
Back in November 2012, Kris tipped this company for Australian Small-Cap Investigator subscribers.
At just 40 cents per share, he believed it was ‘…a great speculation on the changing media industry. [Fairfax] offers the chance to make a big triple-digit percentage gain.’
He was right.
Investors who bought this stock could have cashed in on a 124% gain when current small-cap analyst Tim Dohrmann sent out a sell recommendation earlier this year. During this time, Fairfax has reshaped its business and grown from a $960 million market cap to an enormous $2 billion market cap stock.
My point is, when large companies become small ones, and then recover, they could offer the same gains that unheard of small-cap stocks do. But regardless of whether it’s a new small-cap or an ex-large-cap, much of the analysis is the same.
I asked Tim Dohrmann what he looks for when hunting for small-cap stocks. The key to scoring small-cap gains is to look at how close the company is to turning a profit.
As Tim explains:
‘When I look at a small-cap stock, I like to see a company taking the fight to the big boys.
‘You should look for a little company that’s developing a product that will shake up its market. You should dig deeper if it’s gaining market share at a rapid rate off a low base.
‘The best gains — and the most exciting rides — come when you find a company at the start of that journey, not at the end.
‘It’s hard to get that timing right. But that’s fine. You don’t need a PhD in finance to understand a company’s direction.
‘Pay close attention to when a company’s net losses are getting smaller and smaller, or when a company has just crossed the threshold from making a loss into making a profit.
‘For small-cap stocks, you should pay just as much attention when a company crosses the threshold from cash flow negative to cash flow positive territory.
‘That often indicates a business plan that’s starting to generate wealth.’
Shae Smith+
Editor, Money Weekend
Two Stories from Money Morning This Week…
While we’re talking small-caps, Tim reveals here the two biggest mistakes investors make when it comes to investing in small-caps. These two simple messages will make you a better investor.
The Reserve Bank of Australia calmly assured the Australia public that interest rates won’t be going up any time soon. Kris reasons here that the RBA really meant it was time to buy stocks. Kris reckons these low interest rates mean he is still on target for the ASX to reach 7,000 in January 2015.
And you might like…
Want to see what small-cap stock Tim thinks will give you triple digit gains? Click here to find out.
The post Small-Cap Gains from Unlikely Places appeared first on Stock Market News, Finance and Investments | Money Morning Australia.
