Big victories for two of the smaller players
IT software specialist Bravura Solutions announced it had received a "conditional" proposal from its long-term suitor, private equity group Ironbridge Capital, for 28¢ a share, while US-based oil and gas producer Antares Energy received a $300 million conditional offer for its assets in the Permian Basin - worth more than double its current market value.
There are risks in any investment, but when you are paying very low prices for assets that have relatively big potential, there is less that can go wrong if there are hiccups. You can have many of these types of stocks in your portfolio and a lot won't do anything. But for the ones that do, it will be worth the ride - as this corporate activity suggests.
The sharemarket goes up and down but, historically, it tends to rise more than it falls. This occurs in seven out of 10 years. If you average out its returns, you are looking at about 10.5 per cent a year. And your timing has to be good to generate even this return, even over a number of years.
To generate the sort of wealth to fund your retirement needs, you need to do better than this: you need to hit the ball out of the park on one or two investments. This is what Small Caps - which we define as companies with market caps of less than $300 million - can do.
Stocks such as the banks, Telstra and some internet companies have, until recently, traded at record high levels because investors perceive that there is relatively high certainty that their earnings will appreciate, delivering growing dividend income. These companies have high "price risk", which has been reflected in recent selling. If there is any softening of their earnings growth, their share prices are extremely vulnerable to big falls.
In contrast, what you see with Small Caps is "information risk". In these companies, their historic earnings performance can often bear little resemblance to their future earnings. Yes, there is risk in buying small caps. But there is risk in buying any investment.
Frequently Asked Questions about this Article…
In the space of a week two research tips saw major corporate announcements: IT software specialist Bravura Solutions received a “conditional” proposal from private equity group Ironbridge Capital for 28¢ a share, and US oil and gas producer Antares Energy received a $300 million conditional offer for its Permian Basin assets. Those announcements drove share price increases of about 50% and 70% respectively.
These deals illustrate how corporate activity can produce large, rapid gains for small caps. When assets are bought at low prices and then attract takeover or asset offers, the upside can be significant. Everyday investors who hold a selection of small-cap positions may see many do little, but the few that receive such interest can deliver outsized returns.
The article defines Small Caps as companies with market capitalisations of less than $300 million. That matters because these companies can offer higher potential upside—including the chance to ‘hit it out of the park’ on one or two investments—though they also come with different risks than large, established stocks.
The article highlights “information risk” as a key issue for small caps—historic earnings may bear little resemblance to future earnings, making outcomes harder to predict. It also reminds readers that there is risk in any investment, and many small caps won’t move much; the idea is that a few winners can offset many quiet positions.
Large, established companies are often seen as having more predictable earnings and regular dividend income, which creates a different kind of danger the article calls “price risk”: if earnings soften, their high valuations can fall sharply. Small caps instead tend to carry information risk—less certainty about future earnings but potentially larger relative upside if prospects improve or deals occur.
According to the article, to fund retirement you usually need to outperform average market returns, and small caps can sometimes provide the one or two big winners that generate that extra growth. However, the article also notes you’ll have many small-cap positions that may do little, so the strategy relies on occasional large successes.
The article states the sharemarket historically rises more often than it falls—about seven out of 10 years—and averages roughly 10.5% per year. It cautions that timing matters: achieving those average returns still requires reasonably good timing over time, which is why some investors look for opportunities beyond the market average.
The article suggests a pragmatic approach: you can hold many speculative small-cap positions because many won’t move, but the few that do can justify the strategy. Buying assets at very low prices relative to their potential can limit downside if there are hiccups, while preserving the chance of a big payoff if corporate activity or improved fundamentals occur.
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