Those holding one-time private-investor darling Judges Scientific (LSE: JDG) woke up to a nasty shock this morning as the shares opened around 30% lower. As I write, they’ve bounced back a bit and now sit about 17% down from last night’s close, at 1460p.
The AIM-listed firm specialises in the design and production of scientific instruments. Rapid expansion through both organic and acquisitive growth saw the company delight investors as the share price climbed from circa 400p as 2012 kicked off, to top out at about 2400p in the spring of 2014 after sextupling investor’s money — it’s the kind of investing result we all dream of, but subsequent events provide something of salutary lesson for those active in the small-cap space.
Rapid falls can follow rapid rises
Since flirting with the heights, the firm’s shares are down about 38% this year as the pace of forward earnings’ growth slowed. It seems a particular problem with small-cap investing: momentum can carry the shares too high, and valuations often become stretched. Judges Scientific traded on a historic P/E rating approaching 24 at around 2400p, which looks high compared to forward earnings’ growth predictions in single figures.
For that reason, it pays to be nimble in the world of small caps. If valuations get high and we find ourselves with a big capital gain, we should sell up and bank it, or sell a good proportion of it at least, rather than hang on for even more gains. Let’s be clear about this, selling to lock in gains is good risk management and a valid reason for reaching a sell decision. Selling because of profit is what made the likes of Warren Buffett, Peter Lynch and Jesse Livermore rich. It’s why we buy shares in the first place, to sell at a profit. Don’t be caught up in woolly notions of distinguishing between being an investor over being a trader; it’s all the same thing. Being a winner in the stock market is what counts.
Pedestrian profit growth
Today’s announcement from the company updates about H1 trading, which the directors describe as challenging. Nonetheless, revenue growth of 43% over the year-ago figure sounds encouraging, but includes the results from an acquisition made on 26 June 2013. Without that acquisition, the firm delivered a less startling 3.2% organic growth over the period.
Organic order intake over the six-month period was 4.8% below last year and, overall, orders were 11% below the level required to meet the firm’s sales budget for the year. The order book represents 7.8 weeks of sales, compared to 10.6 weeks a year ago. The directors cite government efforts to contain public sector spending and a 10% appreciation of Sterling against the US dollar during the last 12 months as contributors to the firm’s headwinds.
What now?
After seeing the fun enjoyed by Judges Scientific holders, it’s tempting to ask whether the firm is presenting investors with a chance for a second bite of the cherry now. I reckon it might be. After all, growth is down but not out, and you can’t fault the director’s track record of value delivery as the firm’s earnings rose by about 260% over the last four years.
I wouldn’t bet against management’s knack for pulling off carefully targeted value-enhancing acquisition deals or growing what seems to be a sound business organically. However, I do think forward growth could be slower than what we’ve seen recently, so investors will look for a lower rating.
Right now, the shares trade on a comfortable-looking historical P/E rating of about 14, which makes Judges Scientific a good candidate for further research, in my book.