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fabrice taylor

Fabrice Taylor, CFA, publishes the President's Club investment letter. His letter and The Globe and Mail have a distribution agreement.

You've probably heard of the January Effect, the theory that certain stocks rise in the first month of the year after having been oversold by investors looking for tax losses in December. This strategy can work because opportunities almost always arise when artificial conditions like a tax deadline are imposed on investors.

But it's not enough to just buy stocks that have sold off sharply in December because that burst of selling can just as easily be a sign of a company in trouble as a temporary opportunity. So, to take advantage of these fleeting opportunities you have to look for other catalysts.

For this year I've come up with a list of three small-cap stocks that not only sold off because of tax-loss selling but that offer other highly compelling reasons to invest (they are riskier than average so don't put a huge amount of your portfolio in them).

I started by screening for stocks that were down on the year with a high percentage of the loss incurred in December to try to ensure tax-loss selling was a factor. That yielded a long list.

Then, I filtered out resource firms because they're far more influenced by commodity prices, which no one can predict. Finally, I looked for reasons these stocks might perform well this year, other than that they were cheap thanks to tax-loss selling.

The three most interesting stocks that I found and invested in are, in order of potential upside:

Cortex Business Solutions Inc., which has created a large and fast-growing network of customers who use its cloud-based software to speed up the invoicing process in heavy industries such as energy and construction. Recurring revenue grew more than 40 per cent last year while gross profit margins are a massive 80 per cent. The Calgary-based company has saved Husky Energy almost $30-million a year, which by my math increased its market value by more than $300-million. Husky is only one customer of many, yet Cortex's market value is a fraction of this value creation.

The way Cortex saves customers money is largely by allowing them to pay invoices faster and in so doing apply a small discount to them. Most suppliers would prefer to be paid sooner – 10 days as opposed to 120 – even if it means taking a small haircut on their receivables.

There are two catalysts for this company this year: the first is a brand-new CEO who should be able to accelerate profitability, and the second is low oil prices, which should provide an added impetus for producers to use the network. When oil is $100 (U.S.) a barrel, producers are obsessed with drilling more holes. When it's $50, they need to get aggressive on costs. Cortex's business grew in both 2008 and 2011, when oil prices fell.

IMRIS Inc. designs and manufactures proprietary surgical equipment that analysts say is cutting edge. The Minneapolis, Minn.-based company has clocked revenues as high as $60-million with healthy gross margins, but sales are lumpy. Last year sales fell, and the stock was a classic tax-loss candidate.

The shares have bounced slightly from their year-end lows, but analyst targets are as high as $3 a share, implying four-fold returns if the company delivers. The backlog is very healthy, and suggests a big bounce in sales this year.

The other catalyst for this year? The company, listed on both the TSX and Nasdaq exchanges, announced a capital raise just before Christmas, and insiders – who already owned a lot of stock – took the entire financing for themselves. I've never seen insiders take an entire financing only to watch the company fail, so I assume there is likely to be upside to the estimates.

Finally, Parkit Enterprises Inc. owns and, with a U.S. partner, acquires and operates parking lots south of the border. The stock offers investors a couple of attractive elements: Parking is economically sensitive, so it's a stable way to gain exposure to the growing U.S. economy. Vancouver-based Parkit's lots are located near airports, and are therefore more economically sensitive. Second, it provides cheap exposure to the U.S. dollar.

Insiders were aggressive buyers of the stock at higher prices than the stock currently trades at now, which is close to book value.

The catalyst for this year will be when Parkit raises funds in a limited partnership to finance the purchase of more lots. The company's plan is to earn hedge-fund style fees to acquire, manage and sell lots. The leverage from a fund would provide outstanding returns if the company can conduct good business.