Leni Gas and Oil (LSE: LGO) has been one of the top rising AIM listed stocks so far this year. Its ascent has been extraordinary, and a £1,000 investment made at the beginning of the year would have turned into £6,000 at today’s price. You know, I think most shareholders would have settled for that.
The stock market hasn’t really kicked into gear in 2014. After a great year for shares in 2013, the benchmark FTSE All-Share index has posted a 4% decline since January.
Why, amid a comatose market, has this fledgling small cap rallied so strongly?
Risk factor
When you use your money to invest in shares of a business, the rate of return you can expect is made up of a few factors:
- Part of the rate of return is the time value of money. You’d rather have £100 now than if I promised to give you more than £100 in a year’s time.
- Part of the rate of return is compensation for the amount of risk you’re assuming. In LGO’s case, will the company strike oil or not?
LGO has been drilling in Trinidad, which the company believes will create “medium and long term value” through increases in production over the next few years.
Upside potential
‘Great!’, you might think. We expect that demand for oil is going to increase over the coming years as developing economies continue to grow. Oil is a finite resource, of course, and the result should be that that prices trend upwards. ‘I need to get in on this oil mania!’
It’s not quite so simple.
Leni is embarking on a 30 well development project at the Goudron field in Trinidad. After successfully drilling the fifth well at the beginning of September, LGO moved its rig to another site and began preparing for production. So far, so good.
The problem is that we could yet see production delays or cost overruns. Given that the share price has risen six fold already, it’s difficult to assume that there’s much conservatism in the valuation at present. If there’s a stutter in executing on its projects then the market’s reaction could be fierce.
Where to look for small-cap bargains?
Investing in small-cap companies carries more risk than a ‘safe and steady’ blue-chip. People are lured by the potential for colossal gains, and investors in LGO need to familiarise themselves with the companies balance sheet. Drilling is expensive, and if there are cost overruns or delays, can it continue to fund its operations?
