Jim Slater argued in his book The Zulu Principle that the investor can gain a significant advantage over stockbrokers dealing in large trades by doing what they can’t, namely focusing on a niche area ideally in small-cap territory.

This article outlines some of the measures that can be used to screen and select shares that may be undervalued and ignored by the market. This means looking beyond the FTSE 100. 

1.     Identify A Future Firework

No matter how much investors talk about value investing and the long term, it is immensely satisfying to buy shares in a company that rocket in value within a short period of time.

Companies most likely to do this are smaller in comparison to the FTSE 100 internationals, and so you should screen for shares where the market cap is less than £200 million or similar.

2.     Your Fundamental Shopping List

Look at the earnings per share growth year on year for a period of around five years. Is it above 5% year on year? If it is then this is a business that is demonstrating sustainable growth in terms of shareholder value.

• Look at the PE Ratio (price to earnings). Is it less than 15? A PE Ratio of less than 15 may indicate the business is under-valued and the share price is cheap.
  
• Look at the debt position. Gearing of over 35% could be regarded as higher risk (depending on the business and the sector). Try to find shares in companies with as little gearing as possible.
  
• Investigate the annual revenue and pre-tax profit position over a period of years. Are they growing to a satisfactory level?
  
• Look at the cash flow position of the business. Does it have cash in the bank and if so how much?
  
• Do the assets of the business exceed its liabilities by a comfortable margin?
  
• Look at the current share price. Is it cheap in the context of where it has been?
  
• These are just some of the measures you might consider, however not everything worth considering appears on a balance sheet.
  

3.     Look For Something Special

Does the business have brand loyalty or something that would act as a defence in times of adversity? Do the management have a proven track record of adding shareholder value?

By looking for small-cap rising stars of the future that are below the radar of larger investors and stockbrokers you may see better returns on your investments than by sticking to the companies in the FTSE 100. If you do bag a bargain that doubles in value, take time to reflect and learn. Do not rush to reinvest your profit, it takes time to find bargains. Good luck.

              ‘If, at first, you do succeed, try to hide your astonishment.’
                                          Los Angeles Times

Jamie E Smith is the author of Making Money From Stocks And Shares

This content was provided by one of our users, Jamie