Here's how to improve the odds that your investment isn't a gamble.
You have built up a nest egg and are debating what to do with it.
One option is to look on The Motley Fool and compare savings accounts. 5.45% is currently available. This sounds a reasonable rate of return but the RPI is currently 3.7% and if you are fortunate enough to be a higher rate tax payer, 5.45% nets out to 3.27%. That means the real value of your capital is being eroded.
What about a bet on Chelsea or Manchester United to beat one of the bottom teams in the premiership? Likely odds would be 1/7 which equates to an immediate tax free return of 14.28%. Of course a surprise result would lead to the nest egg being totally eroded, so perhaps this is not the course to follow.
It was this thought process which led me into stock market investment. I wanted an inflation beating rate of return and while I was prepared to adopt a high risk strategy, I did not want to gamble with my money.
A couple of years ago I spotted what I thought were two excellent investment opportunities. My initial purchase of Aortech
(LSE: AOR)
was at 102p and the current share price is 430p, an increase of over 300%. My initial purchase of Carbo was at 15p; Carbo went in administration and the shares are now worthless.
Both were capitalised at under £10m and making losses. In each case I carried out detailed research into the company and their products. I attended the AGM, met the directors and generally satisfied myself that although high risk, they were both investments I wished to make.
But was I making an investment or taking a gamble and is the same true for many small caps? In both cases there was nothing wrong with the product the company hoped to sell. Aortech had a pot of money and was relying for its success on US approval for a medical product, elast-eon. Fortunately approval was given before the money ran out and the price has soared. A number of orders have been won but the company has still has to generate profit or be cash positive.
Carbo was a leading abrasives producer and new management had restructured the business. They had returned to profitability but were not generating sufficient cash. Invoices were factored and the cancellation of a major order led to the cash running out.
Clearly the quality of the product is important but cash is king for small caps and should be top of the agenda when assessing them. How long will the cash last, what options does the company have if the cash balance is running low? They may not go the way of Carbo but a rights issue or placing at a large discount to the current share price can seriously erode the value of your investment.
As more and more small caps join AIM it is essential that you are fully aware of the risks associated with any stock market investment. Make sure that you are investing and not gambling on the equivalent of Sheffield United beating Manchester United at Old Trafford!
Royowns shares in Aortech
