There’s nothing like a speculative small-cap to stir the emotions. The thought of large capital gains in double quick time can tempt even the most conservative of us. Â
The danger is that fast gains can be balanced with toe-curling losses in equally quick time, so the conundrum is ‘timing’. Answer that question correctly more often than not and you could have a bright future in small company investing. Get it wrong more than you get it right and you could set yourself back financially.
Not all small-caps are speculative
I would define a speculative small-cap as one with big dreams and potential, but no profits, or perhaps no revenue. Not all small-caps are like that. Many smaller firms enjoy steady revenues, robust cash flow and reliable profits. We can value such firms with traditional indicators such as price-to-earnings (P/E) ratios, dividend yields and price-to-asset multiples. Such small-caps can be good conservative investments just like FTSE 100 firms, but they have added potential to grow operations fast and so can be very attractive.
Sirius Minerals (LSE: SXX) and 88 Energy (LSE: 88E) fall nearer the speculative end of spectrum, with no revenues or profits but with potential if things go well. And they’re going well for oil and gas explorer 88 Energy. Just over a year ago the firm looked like a basket case and as the chairman said  “was faced with the difficult task of reinventing itself following an unsuccessful program offshore Morocco.” And reinvent itself it did, by taking advantage of the poor investment climate to acquire exploration acreage in Alaska.
A transformational result
That was an astute move. Early in 2016, the firm and its partner Burgundy Xploration discovered oil. Project Icewine is beating the firms’ own expectations and the effect on 88 Energy’s share price is astounding. On 31 December, its market capitalisation was $24.7m. Today it’s around ÂŁ229m and the shares have multi-bagged over three months.
88 Energy’s operations aren’t as speculative as they were but would I be nuts to buy its shares now? Maybe. Markets can overshoot in either direction and 88 Energy is 38% down from its peak during March. The firm seems likely to return to the market for more funds to develop the Icewine project, which will dilute existing investors.
But the firm is still developing the Icewine project and plans more drilling. Further upside could also arise if the oil price goes up. The shares look set to be volatile, so any marked share price weakness could be an opportunity to buy-in.
Unpredictable outcome ahead
Sirius minerals aims to be a fertilizer producer with its mine development project in North Yorkshire. The trouble with investing in such a firm, with only a single mine development project, is that it takes vast quantities of money to build a producing facility and that can lead to uncertainty for investors along the way. The firm’s share price has been volatile for several years.
The story is a good one. Sirius Mineral’s managing director said: “The business that is created from this project will sit as a world leader in the fertilizer industry based here in the UK. It is expected to have a low operating cost structure, high margins and a very long asset life in one of the most business-friendly, stable and dynamic economies in the world.”
Despite such hopes, Sirius shares are still speculative so I’m avoiding them for now.