How you should invest in 2012

Welcome to 2012 – it’s a new year, and it’s a new world of investment.

The last three wrenching years transformed the challenge of investment. And today’s test is one that I am relishing. For years investors have been happy to rely upon rising property prices and fund managers’ promises. But now property prices are falling and miserable fund returns have destroyed faith in the professionals.

To make money, you’ll need to back successful businesses. It is that simple. The source of wealth creation is successful business. And the closer you can get to the source, the more money you will make.

I expect plentiful opportunity. For the UK, this is a new age of entrepreneurialism. Last year a record 480,000 new businesses were created and while many will fail, some will flourish and will lead the revival of the economy.

I want to invest in businesses led by ambitious, smart entrepreneurs. And I’ve certainly met a few of those over the last couple of years. But a great leader is not enough. I think there are four other vital criteria for a great penny share. And they’ll help us find some truly outstanding opportunities in 2012 (I’ll spell out my top five stocks for this year at the end).

My four penny share signals for serious returns

A great product

I look for a great product. It does not have to be a thing that I can touch or hold in my hands. There is nothing wrong with providing a great service like running a restaurant, or relying on your brain power. Some of Britain’s most successful businesses – Imagination Technologies (IMG) and Arm Holdings (ARM) for example – don’t make anything but simply licence out their smart technology designs to other manufacturers.

But whatever the business sells, I am looking for something fresh, something that is not already being done well by others, and something for which customers will be prepared to pay good money.

An easy sell

The best products do one of two things. They either meet a need or create a desire. We found that our cupboards and sheds were overflowing, so Lok’n Store (AIM: LOK) provided more storage space. But Apple (NASDAQ:AAPL) created the desire to listen to digital music on the go. The important point is that if customers need or want a product, they do not take too much persuasion to buy it. You don’t have to talk them into it and that means your marketing budget can be minimal.

 

No competition

Very few companies can claim to have no competition and if nobody is even trying to do what they do, you might wonder whether it even needs to be done. It is also true, up to a point, that the presence of competitors can stimulate the market. After all, if Apple is out there creating the market for iPods and iPads, it is easy for copy-cats to sneak in behind and grab some of the market. Competition leads to lower prices and lower prices lead to lower profits.

But at least in the early years of a business, a unique product can enable it to make fat profits – and fat profits are what drive share prices. I rate the widescreen retinal imaging devices of Optos (LSE: OPTS) as a great product with no genuine competition.

A big market

You can have the best product in the world, but you need to sell it. If you buy a pub in rural England and turn it into a super restaurant, you will have a nice business but your turnover and profit will never rise above a modest level. But Asos (ASC), for example, can sell its clothing worldwide. On-line commerce has transformed the sales opportunity for small businesses – if their product is good enough to grab it. A potential big business needs a potential big market.

If you can find a business that matches these four criteria that’s run by the right people, back it and you should make money – whatever the economic circumstances.

How you should invest in 2012

So here is my advice for 2012. Concentrate on investing in great businesses and forget the rest. Will the euro implode this year? Don’t ask me! Will we have inflation or deflation? Haven’t a clue! If you wait until the economic outlook looks settled and rosy you will probably wait for ever. In the meantime, whatever the economic circumstances, there will always be successful small businesses. Join me this year as I hunt for these real wealth creators.

These stocks certainly meet the criteria I’ve talked about today. I’m still looking for a 325% gain on the tiny drug stock turning silkworms into cash. And I’m targeting a 478% gain on the driller.

• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by MoneyWeek Ltd.

Red Hot Penny Shares is a regulated product issued by Fleet Street Publications Ltd. Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Penny shares can be volatile, relatively illiquid and hard to trade. There can be a large bid/offer spread so if you need to sell soon after you’ve bought, you might get less back than you paid. This can make them riskier than other investments. Please seek advice if necessary. 0207 633 3600.