HIDDEN VALUE: THE SMALL STOCK’S SECRET WEAPON

If you want to make a small fortune, goes the old saying, start with a large
fortune. In the world of small stocks, however, the key to making a small
fortune is hidden value. What does the company have that could make its
shares explode in value? In the case of First Quantum Minerals, the key was
its vast copper reserves in a country set in the middle of political strife. Al-
though the Zambian authorities have become increasingly pro-business in
recent years, the same could not be said for some of its neighbors, notably
the Democratic Republic of the Congo (DRC). Just the possibility of a po-
litical coup from a hostile neighbor can understandably scare off investors.
No one wants to invest in a company that might one day be nationalized.

At times, the clues to a stock’s potential can be subtle. While research-
ing First Quantum, I learned that despite the possibility of neighboring gov-
ernment intrusions, the company had a good record in dealing with its em-
ployees. It operated a small hospital, for example, to provide its workers
with health care. Didn’t it make sense to conclude that a company that
cared for its workers might also look out for the interests of shareholders?
No fly-by-night operation would go to the trouble to construct a hospital.
This company planned to be around for a while—truly, a positive sign.

At about the same time, an interesting article appeared in the New York
Times that cited a surge in the growth of private golf courses in Southern
Africa. What exactly is the connection between golf courses and mining? It
seems that during the political turmoil of earlier times, private golf courses
had been shut down as their members fled Africa. More often than not,
these private clubs’ membership included the managerial class of Africa’s
leading firms. These management professionals were precisely the people
needed to generate business revenue, yet they had been driven out of the
region because of political unrest. Now they were returning. According to
the Times article, the new pro-business climate was generating renewed
interest in leisure activities in the region, golf being just one of them. With
the European managerial class returning, a new day had broken.

This change was subtle perhaps, but it didn’t take me long to draw the
logical inference. One, here’s a company with vast undeveloped resources.
Two, the company actually seems to take an interest in the welfare of its
employees. Three, the influx of quality management professionals was on
the upswing, as evidenced by the boom in local golf courses.

The fourth major point was as yet unknown. What was the potential
for metal prices—specifically, the price of copper? If this company had
what it promised, everything was in place for a phenomenal investment.
The worldwide demand for the red metal soared. Share prices for the
Zambian copper company went from under a buck to over $26!

If you are looking for a similar bonanza, you have to sense the po-
tential before it becomes evident. One place to look is at biotech start-up
firms. Though obviously fraught with risk (almost all of these firms have
no profits in the beginning), these companies often double or triple in price
when a breakthrough drug or diagnostic cure is introduced or, better yet,
approved by the regulatory authorities. Take the case of one such stock I
owned last year. The biotech firm Biomira (BIOM) surged from 80 cents to
close to $3 a share almost overnight following a favorable ruling on one of
its drug studies (see Figure 1.2).

Another biotech Canadian firm, DiagnoCure (CUR.TO), specializing in
the development of proprietary diagnostic tools, likewise had a meteoric
rise, soaring from $1 to over $6 a share, when it introduced its proprietary
prostate test kit (as shown in Figure 1.3). At the same time, the Quebec
City–based Canadian firm partnered a deal with San Diego–based Gen-
Probe, which specializes in distribution of medical diagnostic equipment.
Just recently, Gen-Probe has become a darling of Wall Street, making new
highs day after day. Can it be long before little DiagnoCure is likewise dis-
covered?

These companies are examples of what an intelligent investor looks
for in terms of value. Timing is critical if you are to participate in the lion’s
share of the profits available in these and other stocks. But they illustrate
the potential—if you are selective when you buy and sell. At the same time,
remember that despite good intentions, even the best companies often en-
counter roadblocks and obstacles. Rare is the investor who hasn’t been
knocked around and blindsided by an unexpected earnings report. Even
the best companies underperform occasionally. So the road to profitabil-
ity is not always a carefree course. If you concentrate on finding hidden
value, however, you will find that what a company has often prevails in
the end.