Warren Buffett famously guaranteed that if he was managing only $1 million, he could make 50% per year! This is because the options open to him would be far more numerous in the small-cap market. It's well known that Buffett is partial to "cigar-butt" investing, but that his partner Charlie Munger has long advocated buying growth at a reasonable price.
Without a doubt, one of the advantages held by smaller investors is that they can invest meaningful sums in small and growing companies. This often allows retail investors to buy into a company just as it is beginning to generate profits for shareholders. However, there are many risks in such a strategy and generally speaking only a small part of your portfolio should be invested in such companies. Above all, it pays to remember the words of Charlie Munger: "It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent."
With that it mind, my first smart money small-cap to buy in 2014 is Cryosite (ASX: CTE). At the current share price of 46 cents the company has a market capitalisation of about $22 million, and its 1.5 cent (unfranked) dividend equates to a yield of about 3.3%. The company attained the first Australian license for private cord blood storage in 2001 and has steadily grown that business. For those new to the idea, cord blood is the blood left in the placenta and umbilical cord after birth and some people keep it in cryogenic storage on the off-chance their children require stem cell therapy in the future.
Parents pay Cryosite for storage upfront, leading to significant unearned income in the accounts. However, I think that storage customers would be fairly sticky because once someone has committed to storing cord blood it would be a bit pointless to arbitrarily stop. Especially as medical science continues to find new applications for stem cells. The company's other business is cryogenic storage of samples used for medical trials. Cryosite serves much larger companies such as Pfizer and Johnson & Johnson Research.
But am I being stupid? Well it would be a disaster for Cryosite if their facility burnt down and the company just announced that it expects profits to decrease in FY 14 due to competitive pressures. The latest profit guidance suggests that the company is trading on a forward P/E as high as 27.
My second pick for a small-cap to buy in 2014 is Fiducian Portfolio Services (ASX: FPS). The boutique funds manager and owner of financial planning practices is up over 15% since I covered it in this article about two months ago. The thesis for Fiducian is that it benefits from a rising market as funds under management grow, but its profits are somewhat insulated from a falling market (because it shares the profits of professionals using the Fiducian brand).
But am I being stupid? The company has certainly displayed some baffling capital management, having bought back (overvalued) shares during the height of the pre-GFC boom. Profits will fall if there is a wider economic crash, but the fully franked dividend of 5.2% at the current share price of $1.34 gives me confidence in the investment.
My final smart money stock for 2014 is Anteo Diagnostics (ASX: ADO). Anteo makes a "molecular Velcro" that sticks non-biological matter to biological matter. The company has a product that could save much larger companies money while improving their products. So I'm comfortable that eventually sales and profits will come. For example, Anteo could end up providing its Mix & Go "molecular Velcro" for the manufacture of home pregnancy tests.
I find it difficult to value Anteo Diagnostics, as I have much to learn about biotechs. Investor Matt Sanderson has done most to enlighten the market about the company by releasing a series of posts explaining the business. Anteo currently boasts a market capitalisation of about $138 million. There is some risk of making a stupid investment in Anteo Diagnostics as few properly understand the product or the industry dynamics. But it cannot be denied that successful professional investors are backing the company.
The stupidest move I've made (investing) was to buy shares in a company that I didn't understand. Investors can avoid stupid mistakes by not acting out of impulse or fear of missing out. The best defence against investing stupidity is research. To quote Munger again: "In my whole life, I have known no wise people (over a broad subject matter area) who didn’t read all the time – none, zero."
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Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Fiducian Portfolio Services and Cryosite.
The Motley Fool's purpose is to help the world invest, better. Click here now for your free subscription to Take Stock, The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.