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Plus500 Ltd And The Danger With Small Caps

This one really got to me. I mean, it really did.

It was meant to be the perfect investment. I like investing in small caps, because I know the potential for good returns is far better than with blue chips.

Impressive growth

After all, blue chips are already big companies, so they are likely in the future to just get a little bit bigger (or, quite often, a little bit smaller), whereas small caps start from zero, and then just keep on growing. So if you can spot these companies early enough, you can achieve incredible, multi-bagging returns.

This was, I felt, the case with Plus500 (LSE: PLUS). When I bought in at 470p during the autumn of last year, I knew I was bagging a bargain. This was a company that I could see was going places. Check the historic earnings per share progression and you will understand what I mean: 2012: 10.46p, 2013: 28.50p and 2014: 57.18p. Impressive? I thought so.

Plus500 is basically an online trading platform through which you can buy and sell contracts for difference (CFDs). These are financial derivatives that allow you to go long or short on a stock. It brings the type of trading financial professionals are familiar with to the masses. And as such, I think it’s a great idea and a good company. Also, it was trading at a  single-digit P/E ratio, and had a dividend yield of 7%.

So I bought in. And when the share price started to rise, I knew I was onto a winner.

So how should you invest in small caps? Well, my technique is to buy when the company is oversold and a clear bargain (as was the case last year). Then, by looking at the charts and watching how the share price changes and the valuation evolves, I set myself a sell price.

My sell price with Plus500? 700-750p.

An opportunity missed

The thing is, when you have a successful investment you just want to let it run. If it breaks through 700p, maybe it can make 800p or even 1000p. And even at this high price, Plus looked cheap.

So when I was just reaching my target price, I was thinking of selling but wavered a little. And, to be honest, when you’re busy with a full-time job you don’t always have time to think through your investments. And then the price crashed.

In one day I lost, shall I say, quite a lot of money. But I was clever enough to buy in at the bottom and sell at the top of the dead-cat-bounce. So, overall, I actually made a little money. But I could — and perhaps should — have made a lot more.

The share price fell because the company found some accounts were being used to launder money. And then, as often happens, the firm’s board panicked and sold the company to a competitor at a knockdown price.

I never get emotional when these things happen. I just sold the shares and bought into Fidelity China instead. It was no harm done, just an opportunity missed. In investing, if you can profit from just 25% of the opportunities you spot, you are doing well.

What lessons have I learnt?

So what lessons can I draw? Well, if you have a sell target, stick to it and never waver. It is much better to sell early and lose a bit of money, than sell late and see the trade fall through. And if it does fall through, never get emotional. Just move on to the next investment. Small-cap investing can be profitable, but it is also dangerous.

There is no such thing as a grand plan in investing. It is not about far-fetched dreams, aspirations and brilliant thinking. It is about working hard, grafting and making money where you can. And a lot more than we like to admit is down to luck.

You see, there is no such thing as the perfect investment. You either make money, or you don’t.

Small caps can be dangerous, but they can also be rocket fuel for your portfolio. If you are willing to take the risk to make the extra money, then we at the Fool have uncovered a small-cap that could really fly.

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Prabhat Sakya 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.