The stunning rise of speculative stock PPK says a lot about the state of the market

In 2017, the focus of PPK Group  (ASX:PPK) was on specialised equipment and services for underground coal mines. It had a number of blue-chip customers, including multinational conglomerate Glencore (the largest coal producer in NSW), the BHP Mitsubishi Alliance (Australia's 
largest coal producer) and Peabody Energy (the world's largest private coal producer).

But despite its star-studded client roster, it had been a tough few years for the industry, which had suffered a sharp downturn. PPK, a minnow dancing with elephants, reported hefty losses in the 2015 and 2016 financial years as a result.

The company's share price fell from 88 cents in January 2014 to 14 cents in 2017. At that price it was trading below its "book value", the total of everything the company owns (assets) less everything it owes (liabilities). Its book value was $16.3 million and the total value of the shares (or market capitalisation) was a few million dollars below that.

Pessimism reigned for the stock yet the company's 2017 annual report said that "there were clear indications of a sustained strengthening of the domestic coal sector, which will have positive repercussions on PPK's performance during the coming 12 months".

Then at its annual general meeting on November 20, management confirmed that revenue for July 2017 to October 2017 was 77% higher than for the same time the previous year.

A cheap share price and improving prospects sounded like a good combination to me, especially in a notoriously cyclical industry such as coal mining. Downturns can be savage yet this can lead to spectacular investment results when the cycle turns up again.

Key clue

There was another important clue that the cycle was turning. Directors Robin Levison (chairman) and Glenn Molloy had been repeatedly buying more shares throughout October. I love seeing multiple directors putting additional "skin in the game" and here was a case where the money flows were clearly matching the upbeat rhetoric.

PPK ticked a lot of boxes for me. It was a small company with real potential, committed directors, the likelihood of a cyclical upturn and a cheap valuation. The first point is an important one when I'm looking for stocks that could "multi bag" (rise by several hundred per cent). It's all but impossible for giants like Woolworths or Coles to triple or quadruple over four or five years, for instance. But the right smaller company can offer that potential.

My first purchase was on November 27, 2017, at 19.9 cents a share. And everything continued in a similar vein for most of 2018, with the business improving and directors buying more shares.

Then on November 9, 2018 PPK entered a trading halt for a few days to raise money for an acquisition. During that time, the chief executive of another small company that was also in a trading halt called me to ask whether I would invest more money into his company.

While considering that potential investment, I contacted PPK to see if I might participate in its raising, too. The response was the total opposite to that of the first CEO. Effectively, I was told "don't call us, we'll call you".

It reminded me of the Groucho Marx quip that "I don't care to belong to any club that will have me as a member". The first company was ringing around chasing investors while PPK seemed to have them knocking down its door. It was a positive sign. Yet what PPK did with the money it raised caught me off guard.

PPK acquired AIC Investment Corporation, a technology incubator and commercialisation company. AIC, in turn, owned 50% of BNNT Technology, a joint venture between AIC and Deakin University to commercialise Deakin's patented technology for manufacturing boron nitride nanotubes.

I had no idea what boron nitride nanotubes were at the time (and mostly still don't). But my research revealed that there are potentially many important applications for the technology in the aerospace, defence and other industries.

This deal radically changed investors' perceptions of PPK. Commercialising such technology is likely to present challenges, teething problems and perhaps large setbacks. But investors sent the stock soaring and directors kept buying at higher prices. They were clearly "true believers".

Valuable insight

The share price recently hit $3.34 and PPK has been totally transformed from neglected "value" stock (one with a cheap valuation) to a full-blown speculative darling. And in this respect, it's a fascinating microcosm of today's sharemarket psychology.

PPK's net profit in the 2019 financial year was $1.8 million. Its valuation was around $270 million at recent share prices. For those used to seeing price/earnings ratios in the 10 to 25 range (the lower, the better), PPK's has been around 150. This prompted one wag on Twitter to remark that "anyone with a half decent business [should] float it on the ASX and sell to these [idiotic] buyers".

PPK's current price bears no obvious relation to its recent earnings or the assets stated in its accounts. It has gone from trading at a discount to its book value two years ago to now trading around nine times its most recent book value. To old-school value investors who want to see a stock cheap in relation to its recent numbers, PPK has become a head scratcher.

It's now behaving like one of the small group of hot stocks that have garnered so much media attention recently. These include WiseTech Global, Appen, Afterpay, Pro Medicus, Xero, Nearmap and even an old favourite of this column, Jumbo Interactive.

The potential for each of these businesses seems exciting, but history hints strongly that at least a few high-flyers will strike serious trouble at some stage - if not in their actual business operations, then with investors' sky-high expectations eventually proving too ambitious.

The tricky part with such stocks is balancing the exciting potential with the possibility of it ending up another flame-out on the boulevard of broken dreams. And that can happen quickly, as investors in high-flying tech stocks 20 years ago learned, and those invested in high-flying finance stocks learned a decade ago.

After each of these episodes, investors swore off "high potential" boom stocks. At least for a while. So it's a measure of where we are in the market cycle that they're back in favour today and investors are prepared to look past today's facts and figures and pay for an imagined glorious future.

Managing the risks against the potential rewards is the key to the game. Personally, this has meant selling most of the PPK shares in the family portfolios I manage as the stock has soared to more than 15 times our entry price. But not all of them.

Some of my value investing friends ridicule me for holding any of the stock at this price. But game-changing breakthroughs do occasionally happen and PPK might just have manoeuvred itself into one. The ride from here is likely to be dramatic, I'm just not sure in which direction.

Disclosure: Private portfolios managed by Greg Hoffman own shares in PPK.

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