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Tips for your ASX Small Cap Portfolio

Radar's ASX Small Cap Portfolio performance

Radar's ASX Small Cap Portfolio has continued to outperform major stock market indices and has recovered more than 90% of the value lost in the immediate aftermath of the initial panic in March. Boy does that seem a long time ago!

Although we correctly identified many of the share price recoveries in our universe, and hopefully pointed subscribers in the right direction at the right time, since July, the momentum of the big growth stocks such as Xero (XRO) and Afterpay (APT) has led to some underperformance for the portfolio against indices. If you are lucky enough to have got your hands on one of these outsized winners early, you would sensibly have taken your costs out at some point and let the house’s money run. Afterpay is up over 40 times from when we first started looking at it in 2017! Access our research and sign up for a free trial today.

Read more about Investing in Small Caps. Why we picked these ASX Small Cap gems and their outstanding performance.

Our ASX Small Cap Portfolio has to overcome a number of hurdles. The first is that we cannot move as fast as an individual in control of their own shareholdings. An individual subscriber can react immediately to our published advice, or, in the situation where the pandemic was clearly approaching Australia fast, act pre-emptively to ensure that a portfolio was not destroyed.

Nevertheless, due to our cash balances, and prompt action taken with respect to our largest positions, the worst impact of the damage from the Covid-19 crash was avoided, and some small winners were purchased at the right sort of prices, for instance, Tassal (TGR), Hansen Technologies (HSN), Southern Cross Electrical (SXE) and Austal (ASB).

Another impediment to maximising performance is the need to present readers with a balanced portfolio. An individual subscriber, depending on their risk appetite, the scale of their small cap holdings relative to other investments, and their confidence in their analytical or market skills, might easily opt for a more concentrated portfolio of small caps. In the recent excitement, if one of those stocks was an Afterpay, or a Kogan (KGN) or a Macquarie Telecom (MAQ), all stocks we picked at much lower levels, your portfolio will have done very well. But don’t forget to raise some cash at some point!

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Patience and valuation discipline is key when building your ASX Small Cap Portfolio

As we review the portfolio’s holdings now, we are reminded of the importance of patience, and the need to maintain valuation discipline. We have had to be patient to avoid selling at sharply discounted prices our holdings in Gale Pacific (GAP), now 150% up from its low, Prime Media (PRT), up more than 50% from its low, Capral (CAA), likewise, as well as Boom Logistics (BOL). Many of these value oriented stocks have recovered only more recently, once their published results provided comfort about their balance sheet, even if short-term earnings uncertainty remains.

On the whole stocks like Pacific Current (PAC), Select Harvests (SHV), Evolution Mining (EVN), MNF (MNF) and Superloop (SLC) have provided useful countertrend exposure over both the short and medium term. Positions in these stocks need to be kept small enough that we can afford to ride out any long period of underperformance and even add to those positions if prices become sharply and unjustifiably discounted.

We were just about to take profits on Ecofibre (EOF), reflecting unease with the most recent acquisition in the US, and a sense that a high multiple stock might not be an appropriate place to shelter as the economic impact of the pandemic starts to bite. Too late, as covered in this week’s issue, the company beat us to the punch, and we will now exit our position at a loss at Friday’s closing price.

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Maintaining a defensive position

Apart from our own goals by Ecofibre management, we suspect that this and other growth hiccups may suggest that the market has not adequately discounted the full economic consequences of this pandemic, for both growth and value stocks. Which is why we have a strong desire to retain flexibility through a large cash position (almost $50k) to invest into any downturn, which we think is more likely than not.

Xeroing in on equity market hype

We think central banks’ ability to control longer-term interest rates through negative or zero short-term interest rates has a limited shelf life. And we do not think that paying up for stocks because there is no alternative (the TINA imperative) is a good idea for a conservative investor, one whose primary concern is to conserve capital. We had a quick look at the financial metrics of the accounting software provider Xero (XRO), whose stock has almost doubled since the March selloff. “Maybe this time it is different,” said to be the five most dangerous words in investment. Xero is selling at greater than 20 times sales, over 100 times EBITDA, and 5,000 times NPAT! Historic numbers, yes, and FY20 sales growth of 30% is great, but it doesn’t matter how good the business is, can anything justify that heady valuation?

Be disciplined with your ASX share portfolio

One of the hardest tasks for a professional investor is to keep your investment discipline, while all around others are losing theirs. And making easy money. As we pointed out in a note about a UK stock speculation a few weeks ago, we are in a highly speculative period, caused or exacerbated by essentially free money from central banks. We all know there is no free lunch, and whoever has to pay for the current socially distanced party will be a lot poorer as a result.

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Richard Hemming

Richard Hemming

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Richard is a leading market commentator and expert on ASX Small Caps

www.undertheradarreport.com.au provides investment opportunities in Small Caps that you won’t get anywhere else.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

Under the Radar Report is licensed to give general financial advice only (ASFL: 409518). The author does not own shares in any of the stocks mentioned.

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