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Is The Reward Worth The Risk With Game Digital PLC, Supergroup PLC & LGO Energy PLC?

Do you want to know more about volatile stocks that could deliver terrific returns? 

Keep these three names on your radar — Game Digital (LSE: GMD), SuperGroup (LSE: SGP) and LGO Energy (LSE: LGO). Of course, they could deliver huge losses, too. 

Diversification Rules 

If you invest in Game Digital, SuperGroup and LGO, I suggest you add minimal exposure to these three names, say up to 1.5% of your total invested capital. With them, you’d add volatility and very little extra income from dividends, if any. 

Investment guru Neil Woodford has been buying shares in Game Digital for some time now, and he has been bullish about two other obvious losers, Centrica and Babcock. This is not a big problem for Mr Woodford, however — his portfolio is well diversified and overweights stocks that have rallied in recent times on the back of strong fundamentals, and most of its top holdings offer stable income via dividends. 

SuperGroup

SuperGroup stock has been looking for direction since June 2014, when it traded somewhat below its current level of 954p, dipping to around 850p at one point. The stock is down 45% in the last 12 months, and has traded in the 267p-1,770p corridor over the last five years.

Its fundamentals and its asset base point to a fair value some 20% below the company’s current market cap of £778m, but whether the shares will ever fall that much depends on its growth rate for revenue, operating profitability and cash flows. Forecasts for sales and earnings are a tad bullish, in my view.

Its financials are strong, as the balance sheet carries no debts, although I would feel more comfortable with a higher free cash flow yield for its stage of maturity, particularly now that it plans to start paying dividends. 

The retailer is buying back the exclusive license to distribute Superdry goods in North American because it needs to preserve margins. That’s a sound move, but returns will be diluted. Such a strategy heightens the risk associated with the investment case. 

Game Digital & LGO 

Talking of risk, how not mention Game Digital and LGO Energy?

The former is not investable, really!

Game Digital has lost 10% of value since my last coverage earlier this month, and is down 30% this year. Its CFO, Benedict Smith, is leaving to seek fortunes in the private equity world, and will be replaced soon — it’ll be business as usual, I reckon. 

It’s not clear to me wha the clear competitive advantage of this relatively small outfit is. As a video-games retailer, it faces stiff competition, which will likely continue to put pressure on margins and revenue growth. The shares took a dive in January after a profit warning, and I wouldn’t rule out more volatility in months ahead.

Elsewhere, LGO is down 45% this year, but has bounced back from its lows in the last 10 days or so.

LGO is a speculative bet that should be considered only if you can absorb any LGO-related losses with other income or capital gains from your diversified portfolio.

Its capital structure is stretched, but it could be a high-risk/high-reward in the oil sector. 

I certainly prefer it to Ophir Energy, Gulf Keystone PetroleumIthaca Energy and Xcite Energy, just to name a few troubled companies operating in the oil industry. LGO’s recent performance reinforces that view the business could be turned around and generate huge returns, but only if it delivers good news on its Goudron field in Trinidad in the next few quarters. 

For less risk, you can find more value in a few other small companies whose shares look set to rally, in spite of broader market volatility and their strong trailing performances. 

Our free report includes many value investments that have have beaten the market for a long time, but are not overpriced right now. As the FTSE 100 falters, it's a great opportunity to add the shares of a medical business, for example, which has delivered double-digit returns to its shareholders in recent times...

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Alessandro Pasetti has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.