Why are CRUX Asset Management launching a Smaller Companies Fund now?
By Richard Penny
The pictures above show two very different cars, so which one would you prefer?
Yes; it is a trick question. If these cars were being given away, then of course the car on the left would not find many takers notwithstanding the fact it is an early 1965 variant e-type Jaguar. But of course, the fairy godmother rarely turns up often and even more rarely gives away vintage supercars. Just like you don’t walk into a car show room and buy the newest fastest most luxuriant vehicle…. without asking the price.
For what it is worth the car on the left was found in a Norfolk barn and sold for £41,000 at auction. The car on the right, well it has a new electric drivetrain and is yours for £300,000 plus. I suspect on that basis neither would be a transaction the average reader would nor could gladly undertake.
However, what if I said I would pay you £10,000 to take the car on the left away. Well in that case it doesn’t really matter that the car needs lots of work and hasn’t run for twenty years, there would be queues round the block.
So this is all academic because these opportunities don’t exist right! Wrong!
Not in the sports car market but in the stock market! The outlook for corporate Britain has deteriorated and that has led to downwards pressure on many share prices. As is normal in a downturn this can get overdone.
The worst hit shares are often found in small and microcap companies, companies with less than pristine track-records, growth companies and those that are difficult to understand such as technology and healthcare companies. These shares come under heavy pressure from sellers, and this is when you sometimes find a ‘barn wreck’ that you are paid to take away.
A few weeks ago, we found a faltering technology company with lots of money in the bank. The shares have declined 90% since it launched several years ago, its original business line failed, and it was unprofitable last financial year. The business doesn’t have many fans, but we like the shares. For every pound you pay there is 150p sitting in the bank. There is also another 50p per shares in investments, the majority of which can be recovered.
On closer inspection the company has two divisions: one profitable and one loss making. The profitable business is potentially worth 50-70p per share and it would cost at most 15-20p per share to close or turn around the loss-making business to break-even. This business has a software platform, and the unprofitable division has an opportunity to be ten times as valuable as the profitable one over time.
This is quite a risky business but when the shares are priced this low, we think the risk is between an ‘easy 100%’ profit and possibly 5-6 times the original 100p purchase price. There is a catch. This is a micro-cap company under £200m. With a tricky history and 90% fall initially there is no great story to tell, only the price.
We are beginning to see many of these situations and although the narrative; ‘investing in small companies in a recession’, sounds wrong, often these prices offer spectacular risk reward.
We don’t think you will be paid to take away a classic car any time soon, but we do believe similar risk reward situations will be available in the UK small and microcap market.
“When everyone believes something risky, their unwillingness to buy usually reduces its price to the point where it’s not risky at all”
Howard Marks The most important Thing
‘Please note the views and opinions expressed in this article are based on CRUX’s research and analysis and therefore represent the point of view held by CRUX at the time of publication’.