Why a dog can be an investor's best friend

Those wanting proof that the market has a tendency to chase its own tail need only look at the best and worst performing stocks in the financial year that just past.

Some of the most spectacular small cap performers on the Uncapped 100 in 2012-13 were the biggest dogs in the year before, while some of the worst performers in the last financial years were fallen stars from 2011-12.

Does this mean we can use the “Dogs of the Dow” theory to pick this year’s winners? The theory is a long established belief by some investors that the biggest laggards on the Dow Jones Industrial Average in any given year would rebound to take pole position in the next 12-months.

Business aerial mapping solutions provider, Nearmap (NEA), is a case in point. It tops the leader board for the Uncapped 100 with a stunning 531% surge in 2012-13. Not many would remember that Nearmap had to suffer the indignity of being the eleventh worst performer in the previous year with its 40% plunge from grace.

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The second runner up, Select Harvests (SHV), has recorded a total return of 166%, but shareholders had to put up with a 27% loss in the previous year, making the almond grower the nineteenth worst performer on the Uncapped 100.

Other stocks that have redeemed themselves include footwear retailer RCG Corporation (RCG), dairy products company Bega Cheese (BGA) and gaming systems supplier eBet (EBT) (see The small cap with the biggest earnings upgrade). Both stocks made it to the top 20 rankings.

If you had bought the 20 poorest performing stocks on the Uncapped 100 on July 1, 2012, you would have made an average of 46% for the year compared with a 14.5% gain on the ASX All Ordinaries Index.

Using the same strategy for 2010-11 would have netted you a modest 3% loss, but that stands out well to the more than 11% drop for the All Ords.

But don’t get too excited as blindly buying the ugliest dogs may not be the best strategy. The variation in the returns of the worst 20 is big with roughly half of the stocks generating a loss.

While it is uncommon to find a stock on the worst 20 list for more than one year, some actually have difficulty climbing out of a rut. Crane hire company Boom Logistics (BOL) takes the wooden spoon in this respect. It is the only Uncapped 100 stock that has stayed on the list for three years running.

The other thing is, if you instead targeted the 20 best performers for both years, you would have collected 47% and 9%, respectively.

This doesn’t mean you should not be bargain hunting at the bottom of the Uncapped 100 barrel though. I think the right strategy for those with a stomach for risk is to exercise discretion by understanding the stock’s potential path to recovery over the next 12-months.

Silex Systems (SLX)

One stock on the worst 20 list that I think is well positioned to outperform this financial year is laser technology company Silex Systems.

Silex already seems to be finding its feet after it bounced 7% in the past three days. The stock took a 31% bath in the 2012-13 financial year, which makes number eight on the walk of shame.

The more than 20% collapse in the uranium price to around $US40 a pound and the negative sentiment surrounding nuclear power are some of the reasons why the stock has been out of favour, and the volatility in the solar power industry is also not helping matters.

Silex’s laser is being applied to uranium enrichment and photovoltaics (PV) power generation.

However, as I wrote in late February, there is nothing wrong with Silex itself, and there’s a string of important milestones for the company in next 12-months.

This includes final approval from GLE to proceed with the construction of the first commercial uranium enrichment plant in the US (GLE has exclusive rights to use Silex’s laser for uranium enrichment) and the completion of its one megawatt demonstration PV plant in Saudi Arabia.

Newsat (NWT)

The emerging satellite company is the eleventh worst stock in the last financial year after it tumbled 35%.

However, the share price weakness is related to its large capital raisings to fund its ambition to be the first Australian company to launch a satellite into orbit (see Robert Gottliebsen’s article).

Newsat has so-far achieved every milestone to achieve this end and the probability of success has grown considerably after it managed to lock in debt funding from the US and French export banks.

The launch of the satellite is planned for the end of the 2014 calendar year, but I believe investors will warm to the stock in the months before the big launch date.

Tiger Resources (TGS)

It’s hard to back any mining stock at the moment, particularly those in small cap land.

But as I mentioned in this week’s article (Mining for ROE revival), I believe attitudes towards the industry will change in the coming months.

Emerging copper producer Tiger Resources (TGS) is well placed for any turnaround as the ramp up of its flagship project in the Democratic Republic of Congo continues to exceed expectations.

The miner said today that monthly copper in concentrate production at Kipoi jumped 10% to a record 4422 tonnes in June, taking its year to date production to 20,604 tonnes. This is 11.4% ahead of management’s guidance.

Tiger Resources is aiming to be one of the lowest cost copper producers with an all in cost of around $US1.50 a pound for the life of its mine. The copper price is currently hovering comfortably above $US3 a pound.

The stock has lost 37% of its value in 2012-13, which gives it the dubious honour of taking the tenth spot among the underachievers.

Brendon Lau owns shares in Newsat and Tiger Resources.