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3 small-cap shares to be wary of in 2016

By now, investors are becoming increasingly aware that the real drivers of growth on the ASX are, for the most part, small-cap stocks.

Well publicised by the media, this fact has led many investors into smaller companies in the hope of winning outsized returns like Bellamy’s Australia Limited (ASX: BAL) or 1-Page Ltd (ASX: 1PG), up 800% and 184% respectively in the past 12 months.

However, for every winner, there’s guaranteed to be at least one loser, and it can be difficult to identify these companies among the siren song and promises that many small caps offer.

Here are three small-to-micro-cap speculative stocks that I think all investors should approach with a healthy dose of caution in 2016:

Carbon Conscious Limited (ASX: CCF) faded into obscurity after the Labor government lost the election and the ‘carbon tax’ was scrapped, although it’s back in the eyes of speculators after it announced plans to buy a dairy farm and start supplying fresh milk to China.

This is clearly a bid to capitalise on the lucrative Chinese market a la Bellamy’s and A2 MILK FPO NZ (ASX: A2M), whose share prices and revenues are skyrocketing. However, venturing into dairy is likely to be fairly capital intensive and it remains to be seen if the company can afford it without significant extra funding.

Further, as with many new ventures, I consider there is a significant risk of problems arising along the way. It’s also worth pointing out that as a supplier, Carbon Conscious won’t enjoy the perks of a business like Bellamy’s – which outsources its supply to others.

Investors may also consider a venture into dairy – cattle are one of the world’s biggest greenhouse gas emitters – an about-face for a company previously focused on carbon credits. I have been a CCF shareholder for several years for its eco-credentials, however, I now aim to reduce my exposure to the company.

Newzulu Ltd (ASX: NWZ) has been highly ambitious with the global roll-out of its citizen journalism model and, unfortunately, benefits have been slow to come. Shareholders continue to bankroll the operation through an ever-expanding number of shares and an ever-shrinking share price.

The company inked deals with a number of news providers around the world during the past 12 months, and these could result in a significant lift to revenues in 2016. Unfortunately, the details of many arrangements (such as likely revenues) were not specified, making it harder to determine the company’s value.

Additionally, Newzulu is chewing through cash at a prodigious rate, burning $2.8 million in the September quarter whilst the most recent capital raising only generated $3 million – barely enough for three months of operation at previous cash burns.

Newzulu could start to reduce its cash outflow as revenues grow but with so much uncertainty and no indication of when profitability could be achieved, I believe investors are better off steering clear of the company for now. I continue to hold my shares, although an inability to make headway in 2016 would see me consider selling.

Reffind Ltd (ASX: RFN) is the company I consider most likely to be a winner out of these three businesses, as management has a clear view to profitability and has landed multiple big deals with large listed and private companies. However, like Newzulu above, Reffind’s revenues as yet are very low and the company spent $1.2 million in cash in its most recent quarter.

Reffind has $5.9 million cash at bank and a share price buoyant enough for a capital raising, but that doesn’t overlook the fact that one could well be necessary. Also, Reffind has the attention of many in the market and its share price has been quite volatile recently.

Like Newzulu and Carbon Conscious, it would be very easy to get caught up in the hype for Reffind when it is still a highly speculative business with uncertain revenues. For these reasons I believe investors should be cautious of Reffind in 2016. I personally am not selling my shares, and may buy more at the right price.

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Motley Fool contributor Sean O'Neill owns shares of Carbon Conscious Limited, Newzulu Ltd, and Reffind Ltd. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia owns shares of Bellamy's Australia. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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