here's a tip: dotcoms roaring back

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    Here's a tip: dotcoms roaring back
    John Synnott | August 25 2003 | The Sun-Herald (subscribe)

    Mining and technology firms are suddenly the centre of attention as investors think small, John Synnott writes.

    A mini boom in resource and technology stock penny dreadfuls shares costing only a few cents each is bringing rich spoils to investors.

    It's manna from heaven for tiny companies that have been ignored and starved of funds since the April 2000 dotcom bust when investors went cold on risky ventures.

    There are signs the good times are rolling back. Last week dotcom Multiemedia saw its price double after rising tenfold from less than one cent since May.

    The market was stunned that news of a minor $15 million deal to provide satellite broadband services for UK internet service provider Transcom could prompt a massive 500 million shares to be traded.

    With the property cycle peaking, speculative money is looking for a home among stocks, brokers claim.

    Risk tolerance is rising, lifting stockmarkets on hopes of US and global growth and small companies are going along for the ride.


    "The retail investor is returning with a vengeance and it's not only day traders," Ray Chantry , resource specialist with Baillieu Stockbrokers, based in Melbourne said.

    Mining/materials sectors of the market have been the last to turn up with the stockmarket rise since March. The gold index has risen 35 per cent since then.

    The Iraq war was a watershed, with prospects improving for a US and global recovery, which traditionally lift mining stocks such as BHP and Rio , and take the market up with them, lifting the penny dreadfuls.

    Why resource

    Stocks are hot
    "There has been a dramatic sentiment change in the last month towards resource stocks," Chantry said.
    "China is sucking in resources at a huge rate and there has been a shortage of investment in new mines in the past five to eight years."

    That's good news for stock prices. The danger is a rising Australian dollar it may be pausing before rising with US commodity prices.

    Chantry laments the shortage of small mining stocks a sign of a lean decade for mining and exploration.

    During the mining boom of the 1970s it was a national sport, when everyone's penny dreadful stock hoped to ape Poseidon , which ran up from $1 to $280 in four months.

    Chantry says the boom is back and he predicts a rash of mining floats coming in the next six months to cash in on it with all the attendant pitfalls shown up in the dotcom crash.

    Perth stockbroker Andrew Driscoll of Paterson Ord Minnett says stockbrokers lose research interest in stocks with low turnover because they do not generate income through trading commissions.

    This makes it harder for investors, whose aim is to buy a penny dreadful for two cents and sell when it reaches 10 cents.

    What to look for
    Research should start with a coarse filter over the stocks available, looking for management with a track record of finding gold or other minerals, Driscoll says.

    Vital questions include: Is the asset or area being explored promising? Is it a greenfields site with a lot of work ahead or a partially developed mine? How advanced is the company? Is drilling about to commence? Does the company have a cash flow?

    The ideal is a company that has a cash flow to finance its expansion.

    Shaw Stockbroking 's Brent Mitchell , who trawls among the micro-caps (companies with micro-capitalisation), says prices are moving because of a filter-down effect from rising share prices of the big mining companies BHP and Rio on hopes of supplying a pick-up in US economic growth.

    He has followed Breakaway Resources , which produces copper, gold and silver from the Eloise copper project in Queensland. Its price has doubled to seven cents recently after a five-year slide from 22 cents.

    Popular tips from the Diggers & Dealers mining get-together in Western Australia include Independence Gold , which has jumped 75 per cent in a month from 34 cents, and Sino Gold , which has gradually tripled this year from $1.

    With micro industrial stocks, the improved outlook means investors are more inclined to take a risk if there is positive news.

    "Investors should know why they are buying a stock, because that helps them to know when to sell," Mitchell said.

    And patience is a virtue in the micro-cap field, Direct Portfolio 's investment manager Paul Trainor says.

    In the current climate, investors are inclined to sell those $1 non-performing tech stocks that have fallen to 10 cents. Yet the company may have technology potentially worth $20 million but lack of interest has the market pricing its shares at $2 million.

    "I suggest they buy more and put them in the bottom drawer and wait for them to have a run you do not know what drives these stocks," Trainor said.

    Building a hot portfolio
    A good strategy is to pick 10 stocks and invest a little in each rather than a lot in one and be prepared to lose money on some in the hope that when the market turns others will quadruple in price to pay for the lot.

    EpiTan Limited (EPT), established with the primary mission of commercialising Melanotan as an agent in the prevention of skin cancer and for cosmetic use, missed the tech boom and traded at 10 cents for two years, before recently jumping to $1 and settling at 71 cents.

    Trainor sees promise in HydroMet Corporation , which does clean-up work for Rio Tinto and OneSteel , processing industrial residue, and adding value via the manufacture of agricultural and industrial chemicals and the safe landfill disposal of residual materials. It has a market cap of $11 million and a price-earnings ratio (P/E) of 5.5.

    "This is the type of company you might pick for the future in the hope that environmental clean-up companies take off," Trainor said. "With companies with one cent shares, you are only losing one cent but that can still be 100 per cent."

    The Packers, Pratts and other "high net worth individuals" diversify their investments with, say, 5 per cent of their investments in micro-caps, sometimes directed by their own investment team or specialist stockbrokers such as Emerging Growth Capital (eG Capital ), which has technically trained analysts to sift through companies on offer.

    Investors should look not only at the price, but whether the number of shares on offer is 10 million or 200 million, Mark Fordree , managing director of eG Capital, said.

    Biotech funds
    EG Capital specialises in biotechnology stocks currently the best performing sector in the US.

    "The first question investors should ask is: `What is this business worth, and how does that relate to the value the market is ascribing to it?' " Fordree said.

    "This is not a sector for uninformed investors we don't give advice but there are enormous returns available for people who do their homework."

    EG Capital's biotech fund has risen 50 per cent this year and it plans to launch a new and expanded biotech fund later this year which retail investors will be able to access indirectly through some master trusts.

    Other retail investment funds include Acorn Capital, which claims the title of Australia's only specialist micro-cap investment management company. Its fund, available to investors through the financial services company Australian Unity, returned about 10 per cent for the past three months.

    Risk is relative to reward MMC Asset Management has chased small stocks since 1993 and has been a top performer, doubling the return of the All Ordinaries Index, as well as "relentless pursuit of capital protection and low-risk growth".

    Trent Capital is a new company listed on the stock exchange that finds and invests in tiny companies. It's the creation of Andrew Brown, who moved from a job managing a $40 billion investment pool for Rothschild to get back to investment basics chasing small companies.

    "I'm having the time of my life," Brown said. "It's absolutely fascinating. I have been in the market for 23 years and I have never had so much fun."

    He has basically listed on the stock exchange his private investment company, which looks for undervalued industrial companies to invest in. It can be a long-term investment and he often sells when the companies are "discovered" by the wider market and the share price skyrockets above what he judges the company to be worth.

    There are hundreds of companies out there listed on the stock exchange but ignored by the stockmarket, and low demand for their shares makes them cheap and good-value buying.

    "I have always been intrigued by small companies and how information gaps in the market can lead to gigantic pricing anomalies," Brown said.

    Yet it's risky and the question for investors is which companies are worth the risk.

    Brown has analytical tools at his disposal but believes amateur investors can do it successfully.

    "There's no substitute for homework and it can be enjoyable if you are a small investor who has some knowledge of how the market works," he said.

    "It can suit a retiree with the time available, but for unsophisticated investors it can be punting, and, as with racing, you can do your dough."

    Even hot shots like Brown know from bitter experience how wrong investments in small caps can go.

    A lot of mainstream stock-trading houses do not take the time to examine the worth of small companies because there's not money to be made out of their low turnover of shares.

    There are 720 companies 460 industrial companies ranging from penny dreadful miners to companies with a market capitalisation under $30 million that do not make it into the top 500 companies listed on the Australian Stock Exchange. Some big investment funds have mandates that stop them stepping outside the ASX 500.

    Brown said: "If you have a $20 million company, the major stockbrokers will not be interested because there is no broking income coming from them. So these companies are under-researched with very few people looking at them."

    Riding the risk
    Brown is interested in industrial companies that are not very liquid and so trading at a discount to their worth.

    "You have to be careful. Once you are in, the exit door can be very small unlike BHP. You may not be able to sell if you decide you've made a mistake if you make a mistake the return will be large, with a minus sign in front."

    If the person who built up the company owns half the shares and is not selling, that restricts liquidity. Other risks may be determining whether the founder or people running the company are kosher.

    "You have to have real confidence in them to run their business honestly," Brown said.

    Another big risk with small business is a large customer like Telstra which could take its contract elsewhere.

    The flip side is that lower share prices and potentially higher returns compensate for higher risks.

    "Some of the returns available are very large indeed," Brown said.

    Trent buys shares on the market or approaches companies directly and sets out to be a long-term holder of the stock until it gets an offer it cannot refuse.

    Trent has put $250,000 into financial planning company Snowball Group , formerly Fleet Capital , whose share price collapsed in the past three years and Brown has become chairman.

    Another is WC Penfold the retailer of stationery, office and printing products, which has a market capitalisation of $7 million, has been in strife and is being reorganised with money from executives and Macquarie/KPMG .

    It also has an interest in the commercial printing industry through its 27.1 per cent stake in Penfold Buscombe Limited , which has a market cap of $17 million.

    Brown got interested and bought 5 per cent of the stock when the company distributed shares in the printing company to shareholders. They cost 28 cents but the printing works has a net asset backing of 35 cents and the historic price-to-earnings ratio is a cheap 3.1 per cent. The stock is now trading at 50 cents.

    "The company has a turnover of $105 million so there is a lot of leveraging possible there for improvement by management," Brown said. "And they are committed."

    If you're ready for a little risk . . .

    Count Financial research manger Rachel Griffith said small stocks should comprise 5-10 per cent of a diversified portfolio. The smallest stocks or microcaps could form a proportion of that, depending on your appetite for risk.

    "They can give higher returns, but they are riskier and are not always well researched by brokers, so solid information about them can be lacking," Griffith said.

    Financial adviser Graham Horrocks said there was money to be made in the sector, but not by everyone. "The major thing is to have some idea about what you are doing."

    10 hot resources

    View Resources , 4 cents. An exciting WA emerging nickel producer. (Intersuisse Stockbrokers)

    Palm Springs , 33 cents. The mineral water market is rising 10 per cent a year. (Fat Prophets)

    Indophil Resources , 25 cents. Has large gold deposits in the Philippines moving to the feasibility stage. (Fat Prophets)

    IMF , 66 cents. Previously Insolvency Management Fund Ltd, which funds litigation. (MMC Asset Management)

    Gallery Gold , 19 cents. About to start production of a new gold mine in Botswana. (Lion Selection Group)

    Havilah Resources , 11 cents. A South Australian explorer with good management. (Lion Selection Group)

    Aztec Resources , 65 cents. An emerging WA iron ore producer exploiting the old BHP Koolan Island deposit off WA. (Intersuisse Stockbrokers)

    Breakaway Resources , 60 cents. Diversified junior Queensland copper miner. (Intersuisse Stockbrokers)

    Gunson Resources , 16 cents. WA mineral sands project is promising. (Intersuisse Stockbrokers)

    Mawson West , 15 cents. A gold producer in the Norseman region of Western Australia, due to start production this year. (Intersuisse Stockbrokers)
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