Three Simple Tips for Small-Cap Investing Success

If you want to make real money from the share market, it’s just as important that you adopt a sound strategy as it is to pick the right stocks.

And I won’t pull any punches here. If you want to make serious double and triple-digit percentage gains, you have to play in the small-cap sector. If you hug the blue chips, you’ll find gains like that are as rare as hen’s teeth.

However, some small-cap investors punt away aimlessly for years and end up without much to show for their efforts. I want you to avoid that trap.

There are punters out there…maybe you’re one of them…who buy small-cap stocks purely for the thrill of the risk.

There’s nothing wrong with that. Heck, you can make some good money taking that approach to the markets.

But if you play that game, you need to recognise that you’re acting more as a gambler than a speculator.

And what’s the point of winning a bet if you don’t understand how and why you won it?

The good news is that even the simplest strategy can help you make money more often than not in small-cap shares.

Stock speculation is a tough game at the best of times. But it’s even tougher when you’re flying blind.

If you’ve been an ‘aimless punter’, don’t despair. Today I’ll reveal three tips that will help you straighten up and fly right.

These principles guide my decision on whether or not to recommend speculative investments. You should consider and apply them whenever you’re pondering whether to buy or sell shares in an emerging company.

Whether you’re a beginner or a veteran, I trust you’ll find these tips useful.

#1: Look for ‘Davids’ that could become ‘Goliaths’
When I look at a small-cap stock, I like to see a company taking the fight to the big boys.

There are many ways that little companies can profitably do that.

The best signs are when a firm is successfully innovating, penetrating or consolidating.

You should ask: does the company have a product that will shake up its market? Is it gaining market share at a rapid rate off a low base? Is it acquiring competitors on advantageous terms?

If so, you might have found a David on its way to becoming a Goliath.

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 this leads me to my second tip…

#2: Buy when the numbers are turning around
You might roll your eyes and sigh whenever you see a balance sheet or statement of cash flows.

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.

Some companies’ ideas are so far ahead of their time that it takes the market months or years to appreciate their value. You need patience to invest successfully in a company with these ideas.

But you also need good old-fashioned guts…

3: Don’t be afraid to invest in what scares you
Don’t be afraid to look stupid for owning an emerging stock.

Companies and ideas that took over the world usually started out looking stupid.

It just takes patience and time for these stories to move from the fringe of what seems sensible into the mainstream of the investment world.

You’ll never bank outsized profits by investing in stories that everyone agrees look soothing and sensible.

You have to leave your comfort zone if you want to fatten up your share portfolio.

Don’t bother looking for perfection in your investments. If you find perfection, you’ll know you’ve already missed the biggest gains.

For the best rewards, you have to buy into companies that face risks…as long as you can foresee a day when those risks will go away.

That’s always an exciting journey. And the best part is that it usually involves a stock price growing in leaps and bounds.

The stocks that I analyse in Australian Small-Cap Investigator all face risks. I always make a point of discussing these in each monthly report.

But they’re risks that my research shows the company can overcome.

If you caught my eletter last week, you’ll know I promised you not three, but four keys to small-cap investing.

I’ve only had room to take you through three of those keys today. But keep an eye out – tomorrow I’ll cover the fourth key in fine detail.

Until then, these three keys should keep you at the winners’ table.

Tim Dohrmann+
Small-Cap Analyst, Australian Small-Cap Investigator

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Markets and Money offers an independent and critical perspective on the Australian and global investment markets. Slightly offbeat and far from institutional, Markets and Money delivers you straight-forward, humorous, and useful investment insights from a world wide network of analysts, contrarians, and successful investors.

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