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Building a small cap portfolio

Building a small cap portfolio. Shaun van den Berg Head of Client Education Wednesday, 5 th June 2013. Taking an acorn to oak tree approach. How long does it take an acorn to grow into an oak tree?

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Building a small cap portfolio

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  1. Building a small cap portfolio Shaun van den Berg Head of Client Education Wednesday, 5th June 2013

  2. Taking an acorn to oak tree approach How long does it take an acorn to grow into an oak tree? Itvaries & much depends on the acorn's ability to set down a deep tap root. A fully grown oak tree is 18m to 30m tall. The average rate of growth is just over 610 cm a year, and that would take 10-15 years to get a nice sized tree. Capital Growth How many acorns does an oak tree produce? It depends on how big & how old the tree is, as well as on the weather conditions. For some trees it takes more years than others. It is estimated that they range from 22 000 to 35 000 acorns in a unusual Autumn. Dividends Source: http://wiki.answers.com

  3. Acorn to oak tree: Capitec 01/06/2013 Closing price 18690c 5000 shares @18690c = R934 500 R934 500 capital gain + R75 150 dividends = R1 009 650 10 283% Founded in 1999 Listed on 18/2/2002 115 254 279 shares in issue Market Capitalisation: R151-million(R21-billion) 18/02/2002 Closing price 180c R10 000 = 5000 shares @180c = R9 000

  4. Acorn to oak tree: Grindrod 01/06/2013 Closing price 2045c 31 000 shares @2045c = R633 950 capital gain R633 950 capital gain + R273 730 Dividends = R907 680 Founded in 1966 Listed on 1986 604 665 314 Ords in issue Market Capitalisation: R146-million (R12.3-billion) 6 291% 26/03/1987 Closing price 32c R10 000 = 31 000 shares @32c = R9 920

  5. Acorn to oak tree: Cashbuild 01/06/2013 Closing price 11491c 2500 shares @ 11491c = R287 275 capital gain R287 275 capital gain + R58 075 Dividends = R345 350 2 924% Founded in 1978 Listed on 1986 25 189 811 Ords in issue Market Capitalisation: R98-million (R2.89-billion) 22/05/1987 Closing price 380c R10 000 = 2500 shares @380c = R9 500

  6. Agenda • Introduction • Why Small Caps? • Popularity (or lack of) • Risk • Value • Share Selection Process • Top 3 Small Cap picks • Summary • Conclusion

  7. Building a small cap portfolio Definition of a Small Cap Share Popularity (or lack of) Why Small Caps? Investment Strategy JSE Top 40 & JSE Small Cap Index

  8. Definition of a Small Cap Share • In the US, the generally accepted definition is a share with a market capitalisation between $250-million & $1-billion • R2.5-Billion & R10-Billion • At PSG Online, we consider any share NOT in the top 100 as a small cap share. • #1 British American Tobacco • R 1, 136, 877, 975, 237 • #40 Truworths • R41, 581,375, 488

  9. Popularity (or lack of) • Unfortunately, those definitions do not explain why small cap shares are so popular. • Novice investor / Small portfolio - Small cap shares appear to be the perfect investment.  • Bad name - People "play the pennies" - Nothing more than speculators & gamblers • Hope to strike it rich with that one share that skyrockets.

  10. Advanced Investors • Advanced investors - Maintain majority of portfolio in large caps • Look for companies able to continually raise dividend payouts • Small part (10% - 25%) allocated for small cap shares • Balanced approach to portfolio: • Come across a small cap share which returns 100% - Contribute nicely to your all round share portfolio • On the other hand, if some small cap shares go lower - Whole portfolio would not experience a significant hit

  11. Investment Strategy Large Cap Mid Cap Large Cap SmallCap SmallCap Mid Cap Mid Cap Cash SmallCap SmallCap Large Cap Large Cap Mid Cap

  12. Why Small Caps: Performance

  13. Why Small Caps: Value

  14. Why Small Caps: Relative Strength vs JSE Overall Index

  15. Why Small Caps: Relative Strength vs JSE Top 40

  16. Why Small Caps? JSE Top 40 Index JSE Small Caps Index • Increased by 495% since March 1996 • PE ratio of 17.35 times • DY of 2.75% • Market Underperform • Increased by 636% since March 1996 (28.4% more) • PE ratio of 13.67 times • DY of 3.36% • Market Perform

  17. Why Small Caps? • Easier to analyse • Financial statements & business models • Operate in one line of business • Have fewer competitors • Have a few major customers • Cash generative • Not detracted by Rand • Domestic focus • Natural diversification • Smaller & more nimble to exploit new opportunities/ changes in the market • Better position to generate earnings growth • Hold relatively more upside potential on a valuation basis • Institutional funds are limited from owning them • Few analysts follow them • News flow is poor - information less likely to be reflected in share prices

  18. Risk • Debt- free? Interest cover • Generating cash? Spending money efficiently? Cash Flow / EPS • Turnover & earnings growth beating inflation? • Gross profit, Operating profit & Net profit margins growing? • Company well-positioned to beat competitors? • Generating value for shareholders? Quality Rating > 70

  19. Value • Select shares trading for less than intrinsic values. • Value investors actively seek shares the market has undervalued. • Value investors believe the market overreacts to good & bad news • Share price movements do not correspond with long-term fundamentals. • Result is an opportunity to profit by buying when the price is deflated. • Value investors select shares with lower-than-average Price-to-NAV or Price-to-Earnings (PE) ratios and/or high dividend yields (DY) • PEG ratio = PE / Forecast average growth over next 5 years • Earnings growth rate must be higher than the P/E ratio at time of investing • Price/Net Asset Value (P/NAV) = Current share price divided by the NAV. • Dividend Yield (DY%) = Dividends divided by current share price

  20. Building a small cap portfolio PSG Online: Top 10 Portfolios Share Selection Process Top 3 Small Cap picks

  21. PSG Online: Top 10 Portfolios

  22. Share Selection Process: Top-Down Approach • International Markets • Economic Indicators • Currencies • Precious Metals • Local Markets • Specific Sectors • Specific Shares • Checklists

  23. Fundamental Analysis Checklist P/E < 13 PEG < 75% PRICE/NAV < 2 Undervalued Profitable ROE % > 15% Interest Cover> 5 times Risk Management

  24. Technical Analysis Checklist Bullish Cycles Support & Resistance Moving Averages Trend Lines Oversold OB/OS & Momentum RSI & Stochastic / MACD OBV & VPT Outperformance Relative StrengthAnalysis

  25. Top-Down Approach: Bullish, Outperforming Sectors

  26. Top-Down Approach: Bullish, Outperforming Sectors

  27. Top-Down Approach: Bullish, Outperforming Shares

  28. Top-Down Approach: Company Analysis (Netcare)

  29. Top-Down Approach: Technical Analysis (Netcare)

  30. Share Selection Process: Bottom- Up Approach • Undervalued, Quality shares • Growth at a reasonable price (GARP) • Investing for Dividends

  31. Bottom- Up Approach: Undervalued, Quality Shares Select Default

  32. Small Cap Share #1: Cashbuild (CSB)

  33. Small Cap Share #1: Cashbuild (CSB) • Market Capitalisation – R3-Billion • High ROE / Good cash generation / Strong balance sheet • Indicative of company's strength & potential going forward. • Niche focus of building supplies for the lower LSM segment should sustain growth in the medium term. • Trading at a PE ratio of 9.7 times - Dividend yield of 4.7% = Offers value • Recommend as a buy to longer term investors - Difficult trading conditions

  34. Small Cap Share #1: Cashbuild (CSB) Bearish Volume Accumulation Oversold Underperforming Bullish Divergence

  35. Bottom- Up Approach: Growth at a Reasonable Price Select Default

  36. Small Cap Share #2: KG Media (KGM)

  37. Small Cap Share #2: KG Media (KGM) • Market Capitalisation = R2.7-Billion • Diversified portfolio of assets & Historically recorded strong performances. • Healthy margins / High ROE & Strong balance sheet . • Strong market position - Organic growth seems limited off this high base. • Any outperformance should emanate from an improving economy. • Feel that the share is fairly valued trading on a PE ratio of 13.3 times • Recommend investors to hold their shares.

  38. Small Cap Share #2: KG Media (KGM) Bearish Volume Distribution Underperforming Oversold

  39. Bottom- Up Approach: Investing for Dividends Select Default

  40. Small Cap Share #3: Bowcalf (BCF)

  41. Small Cap Share #3: Bowcalf (BCF) • Market Capitalisation = R720.6-Million • Historically consistent / Solid ROE / Impressive operating margins • In trying economic conditions. • Strong balance sheet & Attractive dividend yield (4.6%) • Offers value trading on a PE 10.6 times & 40% premium to its NAV • Due to difficult trading conditions, only recommend as a buy to longer term investors.

  42. Small Cap Share #3: Bowcalf (BCF) Volume Distribution Bullish Market Performing Oversold

  43. Summary • Small Caps are: • Smaller & more nimble to exploit new opportunities • Better position to generate earnings growth • Hold relatively more upside potential on a valuation basis • Institutional funds are limited from owning them • Have fewer competitors / few major customers • Cash generative • Easier to analyse • Not detracted by Rand / Domestic focus • Natural diversification • Take the acorn to oak tree approach • Undervalued & profitable with manageable risk • Bullish, oversold & market outperforming

  44. Conclusion • Build a solid portfolio – Sit under the shade! • Open a Trading Account with PSG Online • Online Tutorials • Equity Trading Simulator • Research Tools • DataShare Download @R169 p/m • Wen Professional Plus Software is FREE! • Link to the PowerPoint presentation will be emailed soon! • Good Luck • Happy Trading!

  45. Contact Us Thank You Shaun van den Berg Shaunvdb@psg.co.za (011) 996 5254

  46. Disclaimer This publication has been issued by PSG Online. It is confidential and issued for the information of clients only. It shall not be reproduced in whole or in part without our permission. The information contained herein has been obtained from sources which and persons whom we believe to be reliable but is not guaranteed for accuracy, completeness or otherwise. Opinions and estimates constitute our judgement as of the date of this material and are subject to change without notice. Past performance is not indicative of future results. This report is provided for informational purposes only. No information contained herein, no opinion expressed and no recommendation made constitutes a representation by us or a solicitation for the purchase of any of the securities mentioned herein and we have no responsibility whatsoever arising here from or in consequence hereof. Securities, financial instruments or strategies mention herein may not be suitable for all investors and investors must make their own investment decisions using their own independent advisers as they believe necessary and based upon their specific financial situations and investment objectives. The employees of PSG Online may from time to time own securities mentioned herein. Analyst Certification The research analyst who prepared this report certifies that the view expressed herein accurately reflect the research analyst’s personal views about the subject security and issuer and that no part of his compensation was, is or will be directly or indirectly related to specific recommendations or views contained in this report.

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