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Investing 101: Key lessons for small cap investors

Published 09-OCT-2021 13:00 P.M.


15 minute read

Small cap markets were up and down again this week - some days were red but it seems like there are always new investors still interested to buy waiting to come in the next day.

Commodities and raw materials are still feeling strong as global supply chains have been upended over the last 2 years. Gold is yet to have its next run after a big 2020 and our tech positions are all tracking nicely.

Green Hydrogen seems to be constantly gaining momentum in the mainstream news each week - as always we have collated a few of our favourite news articles at the end of this email.

Investing in small cap stocks for 1,000% gains is our goal, while de-risking our position along the way. We have managed to hit a couple since we started our portfolio in 2019, others positions have performed well and provided a great return and some of our positions have been slow to start - tracking sideways or in downtrend for a long time (we are patient and continue to hold these positions).

Each of the positions in our portfolio has delivered a different journey over time and even though we have been investing in small caps for nearly 20 years we are still learning new things every year.

Over the last two years there has been a flood of new, inexperienced investors entering the small cap market.

If you are new to investing in small caps wondering how to get started, the following is not advice, but it’s what we would have told our younger selves when we first started investing in small caps.

(our younger selves most likely wouldn’t have listened though...)

  1. Read our ebook on how we invest in small cap stocks, including lessons we learned from our first 10 years of small cap investing. DON’T do the stuff we did when we started out.
  2. Add 30 small cap stocks to your WATCHLIST. A “watch list” is exactly what it sounds like, a list of stocks that you are WATCHING but not invested in. Set an “entry price” on the day you add a new stock to your watch list so you can track its performance - here is our current portfolio of stocks for some ideas.
  3. WATCH what happens for 6 months - read all the announcements, track how the share prices perform in response to announcements, correlate share price and sentiment to what you see in mainstream media.
  4. Assess what happened - how often did the behaviour of a stock over time match what you thought would happen? Did the share prices on your watchlist perform well? Which stocks did? Which stocks didn’t? Why? Did the stock that you thought was a “sure winner” go up over that 6 months? Did the CEO’s promises happen in the promised time frames? Did a stock go down when they released a “great announcement”?, How would you have done if you had put actual money in? What would you do differently after having watched what happens over 6 months in your watchlist?

(We actually STILL do steps 3 and 4 for stocks we are considering to invest in next...)

If watching sounds too boring and you DO decide to invest, make sure you only invest what you are comfortable to lose, and try to spread across many different small caps to maximise your opportunity to learn and preserve capital in case a few of your positions go south - this is not investment advice but this has worked for us in the past.

The small cap market is a risky and unpredictable place, we believe that a new investor's first few years of small cap investing should be more about learning than about putting on big financial bets trying to strike it big - if you try to swing too big too early you will likely learn the exact same lessons except they’ll just be way more expensive.

It took many, many years before we hit our first 1,000% return where we held a meaningful position, so remember that “staying in the game” as long as possible is important - the longer you are in the small cap market, the more you will see, the more you learn and the more you maximise your chances of getting a win.

“Staying in the game” means diversifying across a number of small cap stocks and keeping your position sizes to what you can afford to lose - again this is not advice - just sharing what worked for us.

When investing in small caps, each new company you discover can sound really good... but there are a LOT of unexpected things that can go wrong and things always take longer than expected- we believe in maintaining a diversified small cap portfolio across multiple broad thematics (when one thematic is down, usually another is up).

What about experienced small cap investors?

What have a couple of crusty, long time small cap investors like myself and Jason learned in the last few years? Well since starting our portfolio model in 2019 we have increased our focus on the following:

  • Patience is key... more patience than we first thought - sorry, not what impatient investors seeking fast money want to hear. When we first started investing, “three months” was patient (which seemed like an eternity at 20 years old). Five years ago we thought “one year” was patient. We now know that the best returns come from holding a (de-risked) position over 3 to 5 years. I wonder what we’ll think ten years from now...
  • Management - getting to know company management and how they conduct themselves - this can be done via attending investor calls, AGM’s and watching the various available company webinars - keep track of promises versus delivery. Back the managers that consistently deliver over time.
  • Performance rights - A “performance right” is a reward for the management achieving pre-agreed business objectives. The reward is new shares in the company. We want to see managers who deliver what they say they will and get rewarded for doing it to keep them motivated in the tough job of growing a small cap company. We prefer performance rights to be tied to business goals rather than to share price appreciation. Existing management performance rights and their terms can be found in company annual reports (open the report and search for “performance rights”).
  • Capital structure - The structure of the shareholder table can make a big difference to how easily a share price re-rates in response to positive news - we now focus on number of shares on issue, options on issue and strike price, who is in the top 20, are large holders escrowed, does management own shares - again all can be found in the company annual report.
  • Be happy when you stick to your investment strategy if you de-risk a position by selling a small portion of your holding after the company has delivered part of it’s plan and the share price has gone up, expect the price will probably keep going up - don’t kick yourself for sticking to your investment plan, instead be happy with your remaining long term position. Remember that share prices can also go down and de-risking will help you stay in the small cap market for longer, even if it means leaving some money on the table on your winners (in our experience at least).

We will try and build these points into our future commentary on each of our investments.

In recent years our favourite part of our work is seeing the company management work through delivering their business plan over a couple of years and how they handle the ups and downs that come with trying to drive growth and value for shareholders. We can’t stress enough how important it is to hear from company management as much as you can. This is easier than ever before with the amount of company webinars available online.

Have a great weekend, here is what happened this week:

📰 This week on Next Investors

This week Euro Manganese (ASX:EMN) announced a joint development agreement with TSX-listed clean technology company Nano One. Nano One has patented processes for the low-cost, low-environmental footprint production of high-performance cathode materials used in lithium-ion batteries.

The co-development will use EMN’s manganese products with Nano One’s battery cathode technology. If it works, then it is likely that EMN will be a preferred supplier of manganese to Nano One (and/or its research and development partners).

Nano One already has partnerships with Volkswagen, as well two other unnamed major automotive companies (one of them is rumoured to be Tesla).

📰 Read More: EMN Enters Joint Development Agreement with Battery Tech Developer Nano One

On Monday our Julimar exploration hopeful Pursuit Minerals (ASX:PUR) announced it has completed two more drill holes and has intersected copper and nickel bearing sulphides.

Importantly PUR now has a better understanding of the actual position of the two EM conductors it has been drilling - one of which it just missed by just 10m with its first drill a few weeks ago.

While PUR moves the drill rig to the next set of targets for more drilling, the cores of these two new drill holes have been sent to the assay lab and we now await results to see if there are any decent grades.

📰 Full Analysis:This time PUR hit it, more drilling incoming...

🗣️ Quick takes on key portfolio company events this week:

Creso Pharma (ASX:CPH)

This week CPH secured $800k worth of purchase orders for its cannabis product. These included a number of ongoing sales with its provincial partners which highlight the demand for the product. CPH seems to be knocking in a steady flow of purchase orders over the last couple of months which we like. We should get a better picture of cash on hand in the next quarterly report at the end of the month.

CPH also provided an update on their medicinal psychedelics play Halucenex (we like the entry into this space), which has commenced “stability testing”. Stability testing is an important step to see if a substance for medical use holds its potency/efficacy over time - so if you get prescribed some psilocybin, will it stay effective as a medicine if left in your medicine cupboard for a few weeks before you take it. All important steps in the process of commercialisation.

Visit our CPH summary page for more.

Galileo Mining (ASX:GAL)

While we wait for GAL to deliver us some more results from the drilling campaign at Delta Blues, this week they announced multiple drill ready PALLADIUM targets with drilling starting in mid October.

This will be a 6 week drill program - always good to have a side bet to the main bet.

Palladium is a key metal in reducing emissions from traditional vehicles, so demand is rising as countries try to decarbonise.

Visit our GAL summary page for more

Vulcan Energy (ASX:VUL)

No news this week but the VUL share price came back under $11 for a little while after VUL raised $200M (huge!) at $13.5 and the cap raise stock came on market unfortunately timed with the Evergrande default jitters a couple of weeks ago - VUL tracked back up to around $12 as this week ended.

The battery metals theme (especially sustainable lithium) continues to be strong and we are excited to see what VUL does next as the lithium price continues to hit new highs each week.

The VUL share price chart over the last 12 months still looks to be in a pretty healthy broad uptrend, and now they have an extra $200M in the bank (plus what’s remaining from the $120M they raised in February).

Visit our VUL summary page for more

Advanced Human Imaging (ASX:AHI)

Last weekend we commented on what we are watching out for next with our investment in AHI - namely their NASDAQ listing and first revenues from their Tinjoy China partnership which we roughly calculated should be about $200k based on industry standard conversion rates on their pre registrations.

For our full comments on what to expect from AHI check out the link here - AHI is currently our 6th biggest holding.

Visit our AHI summary page for more

Province Resources (ASX:PRL)

Our 2021 small cap pick of the year announced that Global Energy Ventures has commenced a Hydrogen export study for the PRL’s “HyEnergy” green hydrogen project.

While the PRL team is busy securing government permits, community approval and the much anticipated Total Eren deal, Global Energy Ventures and their newly appointed consultants will be busy researching the feasibility of using their compressed hydrogen shipping technology to help PRL export its green hydrogen once its ready.

We are seeing a huge amount of media around countries making moves towards green hydrogen, and while the PRL share price has been moving sideways for a few months (while the company is in execution mode) we are looking forward to their next batch of news.

Visit our PRL summary page for more

Invictus Energy (ASX:IVZ)

Our 2020 energy pick of the year IVZ announced progress on its seismic program - “running seismic” is the Oil & Gas exploration equivalent of an EM survey in precious metals exploration, except that large trucks fitted with special equipment send light vibrations into the ground, which can help model potential oil and gas deposits - this information is used to help identify a drill target.

We are expecting IVZ’s loooong awaited major drilling event to happen in the first half of next year (according to their latest preso).

Visit our IVZ summary page for more

Titan Minerals (ASX:TTM)

Our Ecuador gold hopeful TTM has had a busy few weeks after appointing highly credentialed, company building Peter Cook as chairman and new VP of exploration Michael Skeed.

This week TTM completed a $18M cap raise at 10c - now with TTM to go into execution phase we expect decent news flow coming up. We have been holding TTM for over a year now and participated in the cap raise this week. We originally liked TTM’s Ecuador gold projects but they got off to a slow start last year after a bunch of corporate clean up work that had to be done put a drag on progress.

Visit our TTM summary page for more

In our other portfolios 🧬 🦉 🏹

🦉 Wise-Owl

This week we provided an update on Iron Road Ltd (ASX:IRD), who is progressing one of the largest development-ready iron ore projects in Australia.

When the iron ore price hit all-time highs of over US$230/tonne in May, the future appeared rosy for any company able to feed the insatiable demand by steel mills across the world, especially those in China.

However, iron ore prices have since fallen to ~ US$120/t in early October, as China has put its foot down in restricting steel production. To be blunt, iron ore sentiment is very much in the doldrums.

However, history shows us that in this climate those emerging companies are often the ones that are snapped up at premium prices by the majors because of the size of the resources and the scope to add scale to established producers.

Given the size of its resource, high-grade product, and the long-standing support from global resources funds, we believe that IRD remains one of the standout smaller players in the sector.

📰 Read our Full Update: What’s next for our investment in IRD

🏹 Catalyst Hunter

We provided an update on the tiny microcap Ragusa Mineras (ASX:RAS). RAS currently has over $4M in the bank - and with a current market cap of $11M at 8.7c per share, we like RAS’ enterprise value of ~ $7M given the two new projects it recently acquired.

Since we invested in RAS we have been patiently waiting for its WA halloysite tenements to be granted so not a lot has happened in terms of newsflow... yet.

But now that a few months have passed since news of the new project acquisitions, and after taking another closer look at RAS’ September 2021 investor presentation, we think RAS must be getting closer to being able to deliver on its exploration plans.

📰 Read the full story:Surely there must be RAS news coming soon...

🌎 Mainstream Media:

Hydrogen (PRL, EXR, MNB)

Australia on the cusp of a zero-emissions iron ore deal with South Korea (The Age)

Hydrogen’s moment is here at last (The Economist)

Hydrogen era draws Asia closer (AFR)

Branding battle as Forrest and Taylor spar over gas (AFR)

Hydrogen faces $1.6trn investment challenge: IEA (AFR)

Total, Air Liquide Invest in $1.7 Billion Green Hydrogen Fund (Bloomberg)

Traditional Energy (88E, EXR, IVZ)

Hedge funds cash in as green investors dump energy stocks (Financial Times)

A cargo ship of LNG costs $281m. It was just $10m in 2020. (AFR)

US considers releasing emergency oil reserves to tame fuel price surge (Financial Times)

Investors rush to energy stocks to catch boom (AFR)

Global Energy Crisis Is the First of Many in the Clean-Power Era (Bloomberg)

The age of fossil-fuel abundance is dead (The Economist)

A Stock Trader’s Guide to Navigating the Global Energy Crisis (Bloomberg)

Lithium (VUL)

Lithium Prices Are Soaring, Sparking More Deals for Key Battery Metal (Bloomberg)

U.S. Narrows Gap With China In Race To Dominate Battery Value Chain (Bloomberg)Lithium Jumps Again as Miners Can’t Keep Up With Battery Boom (Bloomberg)

Covid-19 Treatments (DXB)

Covid Pill Sales Could Hit $2 Billion, Japan’s Shionogi Says(Bloomberg)

Australia to buy Merck's COVID-19 pill, Victoria cases hit record (Reuters)

Here’s Why Merck Stock May Continue To Rise(Forbes)

Psychedelics (CPH)Seattle City Council unanimously supports decriminalizing psychedelic mushrooms (Fox News)

Telecommunications (VN8)

NZ telco 2degrees lacks spark in IPO non-deal roadshow(AFR)

Have a great weekend,

Next Investors

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