Searching for big gains in small caps: Investment blogger Paul Scott on how to manage risk in a bear market and profit in a bull market

 
Luke Graham
Stocks Continue Downward Slide On Heels Of Yesterday's Extreme Fall
Paul Scott (not pictured) will speak at the UK investor show next April (Source: Getty)

Every investor has their own story of ups and downs in the market, but few are as dramatic as the experience of Paul Scott, an investment blogger for Stockopedia.

After training as an accountant in the 1990s and then spending eight years as a finance director for a retail chain, Scott became a professional small-cap investor in 2002 and had significant success, turning £50,000 into more than £5m over five years. Then the financial crisis hit.

“I lost the lot and had to start all over again in the financial crisis,” he tells City A.M. “It was horrendous, it ruined my life at the time. I had to sell my house, I lost all my savings, I ended up £2m in debt. It was a catastrophe.”

Scott made two mistakes. One was investing in stocks with low liquidity. The other was gearing up on them through spreadbetting. When the crisis hit, he couldn’t get out.

“The bid dried up totally; there were no buyers for the stocks I held in very substantial size and I just had to watch as my portfolio collapsed.”

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Scott now urges caution and will tell people to be careful about how they handle gearing when he speaks at the UK Investor Show in April.

“Gearing on its own isn’t too bad if you’re dealing with liquid things. But if you combine gearing such as spread bets and CFDs (contracts for difference) with small-cap illiquidity, it’s a recipe for disaster,” he says. “Sooner or later you’re going to get stretchered out.”

Scott says not using gearing at all is probably the safest option. Losing millions would scare some away from the market entirely. But Scott learned from his mistakes, resolved the debt and adopted a new approach in 2012.

He sorted all the companies on the market by capitalisation, then eliminated anything with a cap above £400m and below £10m, then removed stocks from sectors he didn’t like, such as property and financials. This left him with around 600 companies.

“I decided to research all of them,” he said. “It took probably a year or two, and I read and digested the accounts of all 600 companies in my universe.”

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Scott’s approach is news-driven. He studies trading updates and results statements published on the London Stock Exchange’s Regulatory News Service (RNS), a channel for companies to communicate with investors.

“What I’m looking for is companies that are outperforming,” he explains.

“Where there’s something either in the figures or in the outlook statement to indicate some sort of turning point being reached, where things are starting to take off. That’s the type of situation where I generally make most of my money. And I find several opportunities every week.”

The benefit of this approach, according to Scott, is it helps to identify potential winners early.

“The big gains are made by the people who are buying straight after the news. But you have to be really careful and really selective,” he says. “It’s a good strategy and works well in a bull market. Whether it’ll work in a bear market I don’t know.”

That’s not to say it’s an approach for everyone. Scott says what works for each person is different and depends on factors such as risk tolerance.

“All I can say is, for me, things work better the more work I put in. The more hours I spend researching companies and reading the RNS the better my performance gets.”

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Overall, Scott’s approach has proven “dramatically good.” As evidence, he keeps a portfolio on Stockopedia’s Fantasy Funds platform, which allows investors to share public versions of their private holdings. His fund, “Beam Me Up Scotty”, is up 264 per cent since its inception in January 2015 and 98 per cent over the last year.

“I post the transactions in real time so people can see it and it’s not possible to change anything,” he explains. “It gives readers of my blog confidence that I know what I’m doing.”

Scott has written a daily market briefing for Stockopedia called the Small Cap Value Report since October 2012. The reports help with his own investing, as it acts as an encyclopedia of notes on all the stocks he’s covered.

“I’ve written that report every day now for about five years. I’ve got a co-writer now, Graham Neary,” he says. “I think I worked out I’ve written the equivalent of 48 books in the last five years in terms of word count!”

Scott thinks the market is still buoyant, but like any sensible investor he is keeping an eye on the exit. “I’m quite humble about what happened to me and I want to help other people understand the dangers of getting carried away in a bull market, which can potentially ruin people’s lives.” During bull runs, people can get carried away and overconfident, according to Scott.

“I think it’s really important to resist that natural feeling that we all have when we’re doing well in the market and try and remember that actually things can suddenly turn very, very ugly,” he adds.

“It’s important to have the skillset to manage risk in a bear market as well as profit in a bull market.”

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