The potential of a greater reward also comes with greater risk, especially with stocks exposed to a particular sector, many of whom can lack the breadth and scale of their larger, more mature counterparts that occupy the FTSE 100 and FTSE 250 indices.

With the above in mind, I thought that I would highlight three announcements from three small caps that caught my eye last week — why I would steer clear of two of them and do some more research on the other, which appears to be in recovery mode.

The Knives Are Out!

First up is Tungsten Corporation (LSE: TUNG). As you can see from the chart below, the shares in this e-invoicing outfit initially outperformed the FTSE 100 by a considerable margin: they peaked at 399 pence each in September 2014, yet have been sliding ever since.

This can often be the case for businesses that initially promise so much… then crash as they disappoint the market with results way below those initially indicated. In July 2014, the EPS figure for the year ending 30^th April 2016 expected by brokers was just under 22 pence per share. As I type, that figure stands at minus 14.5 pence per share — that 36.5 pence downward revision has played its part in seeing the shares crash to around 74 pence each.

Now, it’s fair to say that this could well be a first-class company in the making, but as an investor I would want to see plenty of the green shoots of growth before putting any of my hard-earned cash into the company. Personally, I believe that there will be a couple of additional placings going forward before the company becomes profitable. It will depend on the mood of the market at what price these placings occur – for now, this is not a knife I want to catch.

Next, let’s have a look at Mycelx Technologies (LSE: MYX). This is a very interesting clean-water technology company. It provides water-treatment solutions to the oil and gas, power, marine and heavy manufacturing sectors. Its product MYCELX polymer uses molecular cohesion to remove oil from water. It claims that its technology can achieve oil removal to less than one part per million (ppm).

That’s a pretty impressive claim and, up until recently, the share price reflected the investment thesis of a company at the cutting edge of water treatment, being able to achieve what others struggled to do.

Then, out of the blue, the price of oil collapsed, and explorers either cut back or simply cancelled what had become unprofitable operations. This meant that the company has been forced to revise down its earnings expectations for the full year. In a similar style to Tungsten, analysts were predicting EPS of almost 20 pence per share for the year ending 31^st December 2015 – today, it stands at just under 1.4 pence. That puts the shares on a forward PE of around 20 times 2015 earnings – a little too rich for me.

While I wouldn’t rule out a takeover here, for me there’s just too much risk.

On The Mend?

One company that has caught my eye (for the right reasons) recently is Flybe (LSE: FLYB). This was a company already trying to turn itself around. As the chart below illustrates, it hit a bump in the road – the market marked the shares down accordingly – hitting an apparent low in May of around 53 pence per share.

Since the final results were announced in June, the shares have been on a bit of a tear, as the market seemed relieved that there appeared to be no more unknown bad news forthcoming. Indeed, the shares spiked around 16% when the company updated the market last week. Investors seemed to be buying into the possibility that the 7 E195 jets — currently not suitable for any of the routes that the company flies, which could cost a total of around £80 million — may be offloaded at significantly less cost, coupled with the benefit of cheaper fuel.

As with the other two organisations mentioned above, broker forecasts have been heading south but, given the positive nature of the trading statement, I would now expect brokers to start upgrading their forecasts. Additionally, if management can offload the excess planes quickly, I think the shares could fly a lot higher.

The shares currently change hands in the market on around 12 times forward earnings and may offer a small dividend yield going forward – I, for one, will be doing some further research on this company.

Foolish Bottom Line

There is no doubt about it: investors can make a small fortune investing in the small-cap space of under-researched stocks.

The post Why I’d Avoid Falling Knives Mycelx Technologies Corp & Tungsten Corp PLC But Would Consider Recovery Play Flybe Group Plc appeared first on The Motley Fool UK.

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Dave Sullivan 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.