First, you look at the fundamentals of how to value a business. The value of the underlying business will drive the value of the stock. You should look at cash flow, the balance sheet, and management. You should not be looking at some squiggles on a chart. You are buying a business. There are 10 main things to look for:
- First you look for a company with a strong balance sheet with good manageable debt levels.
- You would want a company with positive cash flow.
- You would want a company with sustainable growth (that is growing cash flows.)
- You want a company with attractive valuations (compared to its peers).
- You want a company with the potential for paying a dividend or a dividend increase. (You will be paid to wait). Small caps should have low payout rates.
- You will want the management team to have significant share ownership.
- You will want to company to be in a business you understand.
- You will want to company to operate in a relatively safe jurisdiction.
- You would want the company's industry to have a positive outlook or the company to operate in a niche.
- You would want a company with hidden values (like owning real estate that is not properly valued.)
A focused diversification in a small cap portfolio is 8 to 12 stocks. Get stocks from a variety of sectors, like management, oil, gas, financial, tech etc. Also have stocks in a variety of regions, like Canada, US, BRIC.
As far as the environment is concerned there is a hint of rationality creeping back in. There is volatility because of what Greece is doing, but this will not affect Canada in the long term.
The first stock he suggested was Exco Technologies (TSX-XTC) which is currently selling at $4.85. It is in the Auto Industry. It has good balance sheet, good governance, solid dividend, and an attractive valuation. The Q3 financials were good. It has cash of $23M, which works out to $0.56 per share. Earnings are expected to be $0.55 in 2012. The P/E is 8.81. Share price is really $4.85-$0.56 cash held. This lowers the price to 7.8 times earnings.
For XTC, the book value is $3.45. The quarterly dividend is $0.04 with a yield of 3.1%. They have a low Payout Ratio. The dividend is increasing with a 25% increase this year. Management and insiders own 35% of the company. It has a good future with good growth in tooling up better engines. See its chart
The second stock he recommended was Capstone Mining (TSX-CS). The current price is $2.40. The sector is mining, mainly copper, but also has some gold and silver. The company has a great balance sheet. Its mining operations are fully funded. There is no debt and it has a strong cash flow. 2012 results were good. It has $5M in cash or $1.27 per share. Half of market capital is in cash.
For CS, the 2012 cash flow is $0.30. Price is only 8times the cash flow. The P/E is 3.76. The book value is increasing. It has growth in its future. The payback period of recent projects is 3 years.
The last stock he recommended was Athabasca Minerals (TSX-ABM). It is on the TSX Venture stock exchange. The sector is industrial materials, aggregate (gravel and sand). The stock price is $1.50. It is a basic and boring company. The balance sheet is improving. It has an attractive valuation. The P/E is 10. The 2012 earnings estimate is $0.175, giving it a P/E of 8.5. Management owns 45% of the company. Their aggregates are used in the Oil Sands. This stock was originally recommended 2 years ago and it is still cheap.
This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my website for stocks followed and investment notes. Follow me on Twitter or StockTwits.