On picking individual stocks

In a previous post from December 2016 I mentioned how a halving of the Santander 123 interest rate to 1.5% prompted me to invest in the shares of Polar Capital, a fund management company.

Although most of my capital has been and is likely to continue be invested in funds and trusts for their diversification benefits, I have invested in a few more individual stocks in recent months primarily in search of yield, but with an eye to future capital growth.

As this has been something of an experiment it’s time for a progress report.

First, the mistakes: in an echo of a previous poor trade in GLI Finance (GLIF) (which I unwound at a 25% loss in early 2016) in 2016 I invested small amounts in KCom (KCOM: the former Kingston Communications with a historic telephone monopoly in Hull) and the packaging supplier Coral Products (CRU). Both had prospective dividend yields in excess of four per cent, both were notable holdings within several successful UK equity income funds.

Yet within six months I’d sold out of both at a loss of 25%.

What what wrong? In a word, results failing to meet expectations. 

In the case of KCom the error stemmed from my failing to pay sufficient heed to the company’s own admission in its 2015/6 Annual Report that near-term revenues might decline as the business restructured.

A sudden share price drop from 120p to 90p last November showed how ongoing growth is essential for sustained share price progress.

In the case of Coral Products a combination of poor execution of expansion plans and excessive debt resulted in a profit warning and a steep share price decline from 23p to below 15p.

With no near-term catalyst for renewal evident in either case I exited both positions.

But – and this is an important lesson – I had a replacement investment in mind. So far it has proved a wise move.

XL Media: Growth without Debt (Part 1)

XLMedia (XLM) makes money from online marketing and publishing. The mechanics of how the company generates profits are explained in its most recent results presentation.

Aside from any ethical qualms about ‘push’ marketing to online gamblers and price-comparison searchers, a major risk here might be regulation. But the company is rapidly diversifying into new revenue sources and thus far has continued to generate impressive growth in cash flow and profits. The recent dividend increase of 5% was a little disappointing but may pave the way for more acquisitions.

The recent post-results rise has given me a paper profit of 30%, almost recouping the loss on KCom and Coral Products within nine months.

The most important factor prompting me to invest was the strong net cash position which stood at $43 million in June 2017. 

Caledonia Mining: Growth Without Debt (Part 2)

A slightly earlier stock pick is also worthy of comment: Caledonia Mining (CMCL). A gold mining company, listed on AIM, based in Zimbabwe…evidence of a foolishly hearty risk appetite on my part? Not entirely.

At the time of my first investment the share price (allowing for a recent share consolidation) was just over £2.00, yet the company had the equivalent of about £1 per share in cash on the balance sheet, was already paying a dividend amounting to 6% and was able to fund a mine investment programme to double production of gold without incurring any debt.

After an astonishing rise to touch £7 at one point, then briefly falling back to £3.50, the shares seem to have settled at just under £5. Meanwhile the gold price has risen to over $1300 an ounce.

The key lesson from Caledonia Mining and XL Media is to look beyond the dividend yield and dig into the balance sheet, the cash resources, and assess the capacity of a company to expand without incurring an onerous debt burden.

K3 Capital Group: Growth Without Debt (Part 3)

My final example dates from just a few days ago: 11^th September to be precise. The Aim-listed broker of small business sales K3 Capital Group (K3C) published strong results five months after its IPO, results strong enough to prompt me to invest.

With a projected dividend yield of around 5%, healthy growth in revenues and profits, and a net cash position, the business has an impetus and momentum lacking in one or two of my investment mistakes: notably the aforementioned KCom and GLI Finance.

Though far too early to judge, the subsequent rise in the K3 share price after the results provides some comfort.

The important lesson from K3Capital is to be alert to a potentially unfolding growth story, whilst ensuring it is based on sound debt-free financial foundations.

What to look for in an individual stock

Individual stock picking, particularly for an income-focused investor like myself, amounts to far more than simply choosing shares with high dividend yields.

Several of the following features should be present:

- a commitment from the management to growing the dividend expressed in annual and interim reports, trading statements, any presentations to investors.

- a capacity from within both cash flows and balance sheet to sustain dividend growth over time.

- growth in revenues, cash flow and profit.

- catalysts for further growth.

- lack of extensive discussion on online forums such as lse.co.uk, stockopedia, advfn

This is perhaps the most important lesson of all: Overlooked companies are more likely to be undervalued.

As ever, the following disclaimer applies: the above is an attempt to explain my investment strategy, not to be taken as financial advice suitable for anyone reading this site.