Investors don’t have much to smile about at present… so why were readers of Red Hot Penny Shares and my other, lower risk newsletter The Bulford Files smiling last week? Has anxiety turned into grinning insanity? Or have they just cracked open the gin?
They are happy because they just made some real gains. I can’t give the names of the companies away – that would be unfair on my loyal readers.
But I can say that one Red Hot Penny Shares recommendation was among the biggest winners in the market last week. And no sooner had the cheers receded than shares in a Bulford Files recommendation followed suit with a very healthy jump in its price.
Why did these companies give their shareholders something to celebrate? They both announced takeover bids. The Red Hot tip agreed a very generous cash offer from a US company. And The Bulford Files tip has agreed to a management buy-out.
This is no mere coincidence. In the face of so much bearishness, there are critical messages here for you as an investor.
Worry about the company, not the market
The first message is this: don’t sell out of perfectly good companies just because the stock market is falling.
Worry about the company and not the market. And by investing in small companies you are ideally placed to do just that. The bigger the company, the harder it is to dodge the crosswinds of the global economy. Many small stocks will hit the skids. But the big banks, for instance, are simply helpless.
Small companies stand or fall by the strength of their products and ability of their management. And there are plenty of small stocks with great products that could yet deliver serious returns in the year ahead.
At this stage, investors need to distinguish between industry sectors that will suffer in a recession, and those that will prosper through thick and thin. Take healthcare. Every year the global population gets older and sicker and demands more medical treatment. A banking crisis won’t change that. I would not touch the financial or retailing sectors but I don’t have the same concerns about investing in medical care.
The Bulford Files tip, for one, is a business that I think looks certain to prosper in the coming years. It helps big corporations to manage their web presence, a job that is about to become much more complicated with the forthcoming expansion of internet addresses.
By focusing firmly on quality companies with bright future prospects, shareholders in these companies have been well rewarded. And I believe these takeovers could be a sign of things to come.
We could see a wave of takeovers in the year ahead
There are two types of takeover. Companies can ‘go private’ because they are tired of the demands placed on public companies and are disillusioned with the investment community. They also see a chance to make good money. Borrowing cheaply to buy into a business with high and reliable cash flow can handsomely reward their private backers. Today’s combination of low interest rates and cheap valuations are the ideal ingredients.
But most takeovers see large companies buy small companies. Maybe they want to get their hands on a new product. Maybe they want to eliminate a dangerous competitor. Maybe it is a means to get into a new region.
Distrustful of the economic outlook, big companies have been piling up cash for the last three years. They have the ammunition for takeovers and with stock market valuations so low they may never get a better chance to strike.
But the key message for investors is this: acquirers are rarely interested in sorting out a mess. Takeover rumours that swirl around troubled companies are normally false and put about by shareholders who want to get out. But good businesses do attract takeover bids. And many of our Red Hot readers are enjoying an excellent run of news recently – from biotechs to medical care groups to oil explorers.
I don’t get it right every time – penny shares are high risk. But if you are interested in reading about what I think are the penny share stories that could defy a downturn, then take a trial of my letter.
• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.
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