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There are many reasons why microcap stocks should form a small part of many investors’ portfolios. The most obvious reason is that microcap stocks can multiply an investor’s money, ten or one hundred times if the share price bounces. More established, mature businesses simply do not rocket up price charts like the most successful microcaps. However it must be noted that they are also the ones that get punished the hardest in a general stockmarket decline, or on negative news. 

Have a look at the 12-month yearly returns on the microcaps listed in the table below. As you can see, returns in the order of several hundred per cent or more have been recorded, led by Beadell Resources at 431% and Aurora Oil & Gas at 346%.

Having said that, share prices of microcap stocks have a habit of sitting around, drifting up and down by a matter of cents for years. They can really test an investor’s patience. And many never grow beyond microcap status.

Clearly, as with all good investing, to maximise your chances of success you have to do your research on the microcaps around before parting with your hard earned cash.

To ensure that we’re on the same page, microcap stocks are companies that fall outside the top 250 companies by market capitalisation. Some microcap stocks have a market capitalisation as low as $5 million, however most microcap funds will not invest in companies of this size.

The biggest hurdle with researching microcaps is that few in the market can help you analyse these companies. Most microcaps are too illiquid for the likes of private clients of broking houses and large managed funds, so brokers and analysts tend not to spend time chatting to CEOs of microcap companies and writing research reports.

So, unfortunately, research rests largely with you – with the exception of a couple of fund managers who specialise in this end of the world.

TheBull decided to take a tour around one of Australia’s specialist microcap managers to give you a handful of the names of microcaps the managers are targeting. Now this might be a place to start your research.

Like you, these managers are searching for the jewel in the crown, the baby Westfield in the making, or the next Cochlear. Clearly, microcap companies do not become global conglomerates over night; it takes decades. But clever management, a healthy market and a solid product should be visible early on. An aggressive attitude to growth, and ambitious management is also a prerequisite.

Acorn Capital Microcap Trust aims to exploit under-researched and relatively unknown stocks to create long-term wealth for investors. And so far, so good. Since its inception on 31 December 2002, its retail fund has delivered a spritely annual return of 15.04 per cent, and 28.61 per cent to the year ending 31 May 2011. And even with the “number of significant challenges facing the domestic and international economies,” Acorn Capital says that the “Australian microcap sector contains a wealth of opportunities.”

Some of the funds largest holdings at 31 May 2011, were Intrepid Mines, Starpharma, Beadell Resources, The Reject Shop, Horizon Oil, Aurora Oil & Gas, IMF (Australia), Integra Mining, Cedar Woods and Reckon.

Just last month, TheBull Premium featured gold and silver exploration company Intrepid Mines, with its primary resource in Indonesia. Shaw Stockbroking’s Scott Marshall pinpointed Intrepid as a small cap to watch, saying “While Intrepid is an exploration company, it’s located and defined a globally significant deposit. While mining approvals are still required, we believe the market has significantly undervalued this company.”

The Reject Shop has been another favourite for investors seeking a retailer that’s more resilient to tougher conditions ahead. Peter Day from Wilson HTM recently commented on The Reject Shop’s impressive management capabilities and agressive growth strategy. The company intends to roll out up to 400 stores from its existing 210.

Horizon Oil is a favourite of Gavin Wendt, of MineLife. He says: “Horizon Oil is my favourite emerging oil exposure because it’s an established producer. It has loads of potential, which is where the investment opportunity presents itself.” Wendt says the company offers substantial and tangible growth prospects, irrespective of the outcomes of individual exploration wells. “The company’s drilling program is essentially appraisal and stgelopment drilling, not wildcat drilling, but still with the very real potential to significantly add to the company’s share price and market value,” he says. “Horizon has a specific exploration and stgelopment focus in South East Asia, with advanced projects in New Zealand, China and Papua New Guinea.”

In TheBull Premium we have also written on Cedar Woods, which is involved in subdividing urban land and building in Perth and Victoria. The company recently issued its third earnings upgrade for the year. Euroz Securities, which holds a Buy recommendation on the company, noted that management recently knocked back a $5.05 takeover offer in March 2011. “It’s now well aware of what needs to be done to justify its decision,” notes Euroz.

As we noted above, great returns on microcaps are real and possible, but be aware that microcaps are the most illiquid stocks in the market and being small, they suffer economic shocks and sharemarket selloffs more brutely than the old market stalwarts.

 Company Name  Current Share Price  12 Month Return  Area of Business
 Intrepid Mines (IAU)  $1.45  173%  Gold, Silver
 Starpharma (SPL)  $1.47  171% Pharmaceutical Technology
 Beadell Resources (BDR)  $0.85  431%  Gold
 The Reject Shop (TRS)  $11.74  -26% Discount Retail
 Horizon Oil (HZN)  $0.33  15.6% Oil and Gas
 Aurora Oil & Gas $3.47  346%  Oil and Gas
 IMF Australia (IMF) $1.56  7.3% Funding for Litigation
 Integra Mining (IGR)  $0.43  52% Mineral Resource Explorer
 Cedar Woods (CWP) $4.07 70%  Property Development and Investment
 Reckon (RKN)  $2.32  12.9%  Financial Software


>>Back to the newsletter to view other articles – July 2nd 2011

Please note that TheBull.com.au simply publishes broker recommendations on this page. The publication of these recommendations does not in any way constitute a recommendation on the part of TheBull.com.au.You should seek professional advice before making any investment decisions.