Indigo Vision is in the video surveillance market. Its main product Video Bridge provides full motion realtime video which they sell to end users via system integrators that set up full video surveillance systems for customers.

Last year the company reported a loss of $2.85m, after a loss of $3.3m the year before. This poor performance has taken its toll and the share price is now trading in deep value territory.

On the balance sheet Indigo Vision reported $24.4m of current assets. These consisted of £8.9m of inventory, $12.9m of receivables and $2.6m.

The company has no debt and the only liabilities are payables totalling $11m. Therefore the net current asset value is $13.4m or approximately £10m, equating to 134p per share. The shares were trading at 112p.

From the balance sheet position Indigo Vision looked very cheap, and with no debt and lots of liquid assets the margin of safety appears adequate.

The problem here is the size of the loss relative to the balance sheet. A £2.2m loss for a company valued at £9m is not insignificant, and it’s taking its toll on the companies cash balance which is down £2.9 from last year.

On the earnings front there are positive comments coming from the company. There was a recent overhaul of senior management and the board of directors and a new turnaround strategy has already been implemented. The aim of which is to break even in 2018.

Time will tell if that target is attainable, but at a 17% discount to net current assets the share price is already pricing in a great deal of pessimism, and therefore any turnaround in their fortunes should be rewarded quickly.

I purchased the shares in September at 110p. The share price hasn’t budged since, and currently sits around 114p.

With the dominance of Amazon and the rise in online retailing, traditional high street stores that have failed to establish a strong and niche online presence have been hit hard. Steep share price declines have seen more and more retail stocks developing deep value characteristics. Game Digital is one of those retailers.

The video game and console retailer went into administration in 2012 and was bought out by private equity firm Opcapita in a deal backed by US activist hedge fund Elliott. After some restructuring they were re-listed on the LSE, and Opcapita still owns 38% of Game Digital with a strong influence on the board of directors.

Mike Ashley has also recently increased his stake in Game to 26%, which has seen Sports Direct and the Belong arenas operated by Game begin a new strategic parternship.

As always with deep value investments the attraction of Game lies not in its uncertain future profitability potential, but in the cheap ratios by which the company is valued compared to its net liquid assets.

From the balance sheet on 28th July 2018 current assets totalled £157m, of which £78m is inventories, £20m receivables, and £58m in cash. All liabilities totalled £101m, the majority of which is trade payables. This leaves our net current asset value at £56m or 32.5p per share.

When I first started buying the shares at 29p this represented a 10% discount to net working capital, which to me presented a prudent haircut to the £78m inventory. Note that the cash alone equates to 33.5p per share, meaning at 29p the stock has been trading at a 13.5% discount to the cash in its bank account.

The recent move to develop their Belong brand, which operates live gaming arenas is encouraging and has the potential for profitable expansion. How successful this new venture will be is impossible to say, but the margin of safety here is sufficient to generate the asymmetric payoffs we are seeking from deep value investments.

The share price has since provided opportunities to buy more stock at below the net current asset value. Most recently in December the company announced that they were going to re-list their shares on the Alternative Investment Market. For some reason this was taken as a negative for the price, despite having no impact on the underlying value of the company.

At the time of writing the shares are currently trading at 24p per share.

Thruvision initially appeared on one of my screeners in February and the most recent company release detailed the sale of their video business to Volpi Capital for a cash sum of £27.5m. This was instantly eye-catching given that the current market capitalisation was £21.5m.

The video business made up the vast majority of the firm’s revenues, and all that was left was a small and unproven scanner business that according to the annual report contributed less than £1m to the total revenue figure.

Crucially the company hadn’t published any financial statements since the sale, so it was clear then that the key to valuing this company was understanding the details of the disposal. This involved determining which current assets are remaining and which were being transferred in the sale.

The deal was done on a “cash free debt free basis” meaning that all cash that the company had was to be kept by the remaining entity, as were all debts and utilised overdraft facilities.

From the last balance sheet in the interim results ending on 30th September 2017 there were no outstanding debts. However in the notes to the financial statements there was reference to a £6.2m credit facility utilised after the balance sheet date. This would be retained by Thruvision.

Management said in the statement that they would use the cash proceeds to pay off all existing debts. The 27.5m cash receipt from the sale of the division, minus the £6.2m credit facility leaves us with £21.3m, £19.3m of which is received immediately and the remaining £2m pending the satisfactory completion of an existing project.

Prudently ignoring the additional £2m the £19.3m equates to 11.68p per share. The stock was currently trading at 13.1p. A 12% premium above the cash the company had sitting in the bank. This effectively valued the brand, products, and any future cash flows at just £2.2m.

This is where some good fortune came my way. On 21st February the stock fell 22% in one day. Believing I had missed some news, or some inside information had been leaked I held off from buying the shares. Two days later though the reason for the decline became apparent.

A regulatory release by the company indicating that a large investor had crossed a holdings threshold requiring a declaration. Henderson global investors, who held over 20% of the company’s stock had recklessly dumped a large portion of its holdings onto the market. The market maker kept moving the price further and further down and Henderson kept selling.

Because there was no fundamental change in the value of the company this price decline only strengthened my conviction. The stock was now trading at 9.9p representing a 15% discount to the cash in its bank account, with the implication that the company has absolutely no value.

The remaining company designed and built scanners that can scan for concealed weapons from up to five metres away. They claimed that they had already interest from government security agencies. Now I am the first to admit that I had no idea about the future prospects of this business, the quality of the product, the sales team, or the senior management. But the best thing about a valuation such as this one, is that I didn’t have to.

At a discount to the net cash I had effectively an extremely cheap call option on the stock. The worst that could happen is the company slowly burns through its (relatively) vast cash balances and eventually shuts down. With the loss in the Thruvision business in 2017 totalling £200k I estimated that this would take a while. If the scanner business took off then the potential returns are significant. This is the sort of asymmetric bets that have great positive expectancy and should always be taken advantage of.

I bought shares at 9.9p

What happened next:

Most value plays such as this require patience, as the positive reports of progress gradually expose the undervaluation. Fortunately this one did not. Two weeks later Thruvision released their first update as a stand-alone company, stating their current cash balance and announcing the progression of a government security contract in the United States and the stock rallied to 13p.

Over the following months the price continued to rise on news of new contracts. The company announced a tender offer at 17p per share to buy back approximately 20% of their shares. I tendered my full position and due to the undersubscription of the offer I ended up selling my full position at 17p, paying no transaction fees in the process.

This turned out to be my first mistake with this analysis. Upon completion of the tender offer the share price immediately jumped to 19p, and within two weeks it was trading at 25p. It fell back a month later but has gradually made up the ground again and as of December 14th trades at 27p.

Hindsight is 20/20 but at the time I did not believe I would get filled on my whole subscription in the tender offer. The investment was also a very different proposition at 17p. An unproven business valued largely on the promise of future contract negotiations, the margin for error here was small.

At a conference hosted by one of the world’s largest investment banks, stood behind a podium, a self-assured brazen young man in a tailored suit boasted without pause or hesitation, that he and his colleagues on the bank’s event driven trading desk could time their trades better than anyone else.

They can do this, he said, because their wide-spanning prime brokerage business meant they alone could see the portfolios that account for 10% of all trading volume on the New York Stock Exchange, and time their trades based on monitoring the activity of their clients.

Later that afternoon an ambitious young equity analyst confessed unpolagetically that she used the current account data of the firm’s retail banking arm to predict the next quarter’s sales for the high-street brand stocks that she covers.

Her co-speaker then said that their research department had access to satellite data that monitors the number of cars in a supermarket’s car park that they use to forecast the shop’s interim earnings.

Meanwhile after a long hard day at the office Alan takes a seat in the small study at the back of his house. Armed with his laptop and a copy of The Times business section he uses the half an hour he has before bed for a quick scroll through the entire stock market to see if he can happen on some profitable investment opportunities that the aforementioned professional analysts have overlooked.

A key assumption of the efficient market hypothesis states that all new information about a stock is almost instantaneously absorbed, interpreted and analysed by market participants and the price of the stock in question will update to reflect this latest development in the future earnings prospects of the business.

While this assumption in the extreme is patently untrue, it should cause us to pause for thought on how information about a public corporation is disseminated and evaluated by the investment community.

Equity research analysts are among the hardest working people in the investment industry. At international brokerage houses and behemoth investment banks around the world these people work day and night pouring through every piece of information available on their niche group of companies.

They can call on their vast industry networks, their firm’s bottomless pockets and cutting edge data analysis. They do this because they have to. In a market where hundreds of analysts are a combing the same financial statements, announcements and industry forecasts the marginal benefit of this effort diminishes. Each analyst must work longer and harder than ever to get the smallest of edges over their peers.

So while sitting in his back-room office flicking through the pages of the weekend business section and believing whole-heartedly that he can predict the future course of a company’s earnings better than these industry titans, is Alan simply delusional?

The answer may be disappointing but all hope may not be lost for the retail investor. Trying to beat the banks, hedge funds and brokerage houses at their own game is a guaranteed road to ruin, leaving your investment returns on the wrong side of a game of chance.

But what if there were a different game, where for once the retail investor had the edge and were able to stack the odds in their favour. The stocks with the smallest market capitalisations have a much smaller analyst following, and this is for several reasons.

Firstly for institutional investors, who are the main producers and consumers of professional market research, micro cap stocks are simply not worth their time. For the largest investment managers, even a 100% stake in a company with a market capitalisation under £25 would amount to little more than a sliver of their overall portfolios, often measured in the billions.

Therefore it would be highly inefficient of these firms to commit anything more than a small fraction of their analyst’s time and resources to the research and valuation of such companies. The inevitable result of this section of the market being ignored by the main players in the investment industry is that the flow of information is severely limited.

In turn this enables mis-valuations to occur and persist, and therefore opportunities for those who are able to take advantage.

But even if an institutional investor did stumble across such an opportunity their size, usually an advantage in the modern financial world, becomes a significant hinderance.

Returning to the example of the £25m pound stock; in order to take a position offering the opportunity for a profit of any significance the firm may decide that it needs £5m worth of stock. Initially amassing the 20% stake in the company required would be difficult. The liquidity of micro cap stocks is incredibly thin and there may simply not be enough shareholders willing to part with their shares at a reasonable price.

In this case the buying pressure could force an upward surge in the share price, removing the very opportunity that they sought to exploit.

An even trickier proposition comes in the form of the eventual exit from their position. In the absence of another institutional investor making a block bid for their holdings the firm will be forced to dump their substantial holdings onto an illiquid exchange. In a crisis scenario where the companies prospects have significantly dimmed, this may prove impossible.

Step up the retail investor. The increasingly rare economic occurrence of David having an edge on Goliath. The size of the position relative to the total market value of the company in which they are investing is of no consequence to the retail investor.

Whether their £5k holdings represent a 0.02% holding in a £25m company or a 0.00002% holding in a £25bn company will not affect the retail investor’s ability to enter or exit their position with ease and without any material impact on the market price.

And so with with these offerings of profitable opportunities off limits to the big boys, it appears the message to the retail investor is to trade in their live savings for as many penny-stocks as their broker will let them get their hands on.

Along with the potential for undervaluation these companies do present significant risks over and above those of larger corporations. Unproven businesses with little or no track records, reduced auditory and regulatory scrutiny, and the propensity to go from rags to riches before swiftly returning from whence they came, should rightly provoke greater caution from a prudent investor.

Championed by value investors the world over, this is where a margin of safety becomes more necessary than ever.

By purchasing companies with strong liquid balance sheets, trading at very low multiples of their net liquid assets we can significantly reduce the potential downside on our investments.

The illiquidity of trading and inhibited information flow means these stark mispricings occur far more regularly than in larger companies. With institutional investors kneecapped by their size, these opportunities can persist, waiting patiently for the retail investor to make their move.

In the coming weeks I will be writing about examples of such stocks that I have already found that present these characteristics. Some of these have already proven profitable. Then going forward I will be writing about new stocks as I find them, and time will tell whether the value retail investor strategy will offer the returns of which I believe it is capable.