In most areas of life, professionals have an advantage over amateurs. I wouldn’t like to go toe to toe with Tyson Fury or face Shoaib Akhtar bowling at 100 miles per hour.
But there is a dark secret in the heart of financial services, that insiders don’t like to talk about: the professionals are at a disadvantage against the amateurs. Because of the way the professionals are paid, taking a small percentage of the total amount they manage, professional fund managers are under pressure to be big. Blackrock, the largest, now manages $5 trillion. A small percentage of 5 trillion dollars is still a very big number.
This means that there is very little incentive for professionals to look at companies which are less than £100m market capitalisation. Even if they get things right, it is far more important for the professional fund manager to predict (guess?) a 20% movement in a large company like HSBC than identify a small company that will quadruple in value.
But it is in precisely this area where the greatest opportunities can be found. For instance one of my smaller companies, red24 has been bid for. I bought at 7.25p per share a few years ago, and now iJET International is paying 26p per share. Almost a 4 bagger in six years.
The history of red24
The history of red24 is interesting. It listed in London on the AIM stockmarket in May 1999 as Perthshire Leisure plc, at 107p per share, close to the height of the stockmarket bubble. The company then sold its Scottish hotel (from where its name presumably derived) and instead operated late night bars such as Abigail’s Party in Soho.
But post September 11, people didn’t feel like partying, the shares rapidly lost value. Then in 2002 the company then changed its purpose and its name to ARC Risk Management Group – providing corporate risk management services. Security training, consultancy and red24.
By 2007 the shares had fallen to less than 2p a share, as the first two activities struggled. But red24 division was doing well. And in March 2007 the company changed its name once again to red24, to reflect the fact that this was now the most successful part of the business.
Travel safety and security, kidnap for ransom and extortion
I bought a few years later at 7.25p per share in September 2010. From hotels, then bars, then security training, the business had now become a database business, specialising in travel safety and security, kidnap for ransom and extortion, product safety and recall, corporate investigations, due diligence and employment background screening, identity theft and fraud, and cybercrime. They set up a Call Centre in South Africa which provided paying customers access to information, and advice from specialists 24 hours a day, 365 days a year.
Management had also done a deal with HSBC, who packaged the service into its “value added” platinum bank account customers. This gave me some reassurance that the information that red24 tracked was valuable. At the time I bought the shares on 5x earnings, and the balance sheet was net cash.
In fact revenue has only grown by around £1m in the last 5 years, but the shares have been re-rated as investors worked out that the new activities were profitable. If you operate in parts of the world where you are worried about your employees being kidnapped, it makes sense to use red24.
And now it has been bid for at almost 4 times what I paid for the shares.
So I’m rather pleased. Currently only 12% of the UK equity markets is owned by individuals. The rest is large institutions like pension funds, insurance companies and specialist fund managers, plus overseas owners. Moreover, these professionals don’t seem keen on trying to use technology to solve this problem. Instead fund managers invest money in data and analysis, trying to beat each other in large liquid markets. But an algorithm would never have discovered red24. The company changed its activities three times, and even if they had noticed, a 4 bagger like red24 would still have been only a rounding error in their portfolio. I wouldn’t like to suggest that there is no risk investing in smaller companies, I do lose money sometimes. But I know I have an advantage versus the professionals, buying and holding good quality, small illiquid stocks.
It’s as if the professionals, by focusing most of their attention on large companies, are only playing on a fraction of the available pitch. And that creates and advantage for amateurs like me to play against and beat them at their own game. I might even celebrate at Abigail’s Party, but I think the bar closed down years ago.