MORE PROFITABLE, LESS RISKY AND WAY MORE FUN
Peter Hodson offers up five small cap companies that should be on your radar.
We here at 5i Research like small cap stocks — a lot. After all, there is nothing like finding an unknown company, doing some research on it, telling investors about it, then watching it succeed. It is a great feeling. We were the first company to cover Amaya Inc. (AYA on the TSX) when it was tiny, and, even though the past year it had some difficulties, the stock has still gone from less than $3 per share at the time of our first research report to more than $22 per share this week.
Most investors shy away from small companies because they fear they are too risky. They certainly can be, but we need to point out the difference between fundamental risk and share price risk. Sure, a small cap company’s stock price can sometimes be very volatile. If you are selling on a ‘bad’ market day you might take a big hit. But many small companies are highly profitable, sitting on lots of cash and/or pay a dividend. Their fundamental risk may not be as high as you think. Put another way, which is riskier, a small company with no debt and good cash flow, or a much larger company losing money and bleeding cash? Financial advisers are also not keen on recommending small caps to their clients, because some small companies will certainly perform poorly, and these will make the adviser’s judgment look bad. However, the real reason many investors avoid small cap companies it that they have simply never heard of them. Let’s try to change that today, with a list of five small companies we think have some solid long-term investment potential.
1 Photon Control (PHO on TSX-V)
After an 88 per cent one-year gain, Photon’s market cap has risen to $159 million, and it just got its first Bay Street analyst report. It has no debt and more than $30 million cash, with projected earnings of $0.09 per share this year. PHO makes optical switches, sensors and other products for the medical, oil and gas and technology sectors. In the fourth quarter, sales rose 47 per cent and the order backlog increased 57 per cent. The company has been profitable on an annual basis each year since 2009. Insiders own 6 per cent. If the company can deliver continued growth, the stock looks very cheap. PHO is certainly starting to gain some traction with investors.
2 Intrinsyc Technologies (ITC on TSX)
ITC, market cap $48 million, has been around a while, but new management seems to be doing a very good job these days. The stock is up 60 per cent in a year, trades at 18X earnings, and the company has no debt and around $8 million cash. Revenue grew by 39 per cent in 2016 with net income of CDN$2.2 million for the year. Recent contract wins set up decent growth prospects for this year as well. ITC develops and sells embedded devices, including products used in the Internet of Things sector. Insiders own about 12 per cent.
3 ZCL Composites Inc. (ZCL on TSX)
We like dividend increases from companies, as they tend to telegraph future results. Companies do not raise dividends without careful consideration of their future. So when a dividend gets raised 50 per cent, as it did in early March with ZCL, we tend to pay extra attention. When that dividend increase is followed by the declaration of a special dividend (65 cents per share) as well, then we really take notice. ZCL, which makes composite underground storage tanks for the oil and gas and water sectors, has been doing very well. The stock (market cap $417 million) is up 78 per cent in the past year. Its dividend yield is 3.5 per cent, and earnings growth in the 20 per cent range is predicted in the next two years. It has no debt and $38 million in cash as of the last quarter. Its business looks good as environmental regulations force companies to improve storage operations and 30-year tanks currently underground get replaced.
4 goeasy Ltd. (GSY on TSX)
Goeasy provides furniture and other products on a rental basis to consumers, and also has a very fast-growing consumer lending business called goeasy Financial. This division saw recent revenue growth of 25 per cent. In the fourth quarter of 2016, total sales rose 10.2 per cent, with 12 per cent same-store sales growth. Net income rose 10.8 per cent. GSY is buying back stock on a regular basis and in February increased its dividend by 44 per cent. Market cap is now $406 million after a 62 per cent oneyear gain. Insiders own about 5 per cent. With solid growth and a 2.4 per cent dividend that has also grown, one might expect a high multiple on the stock. But, even after more gains this year, GSY still trades at only 10X forecasted earnings.
5 BSM Technologies Inc. (GPS on TSX)
BSM provides asset management, asset tracking and asset monitoring solutions through wireless technology. We just issued a research report on the company, although it does have some other coverage on Bay Street. Market cap is $125 million, shares are up 56 per cent in a year, and insiders own 2.6 per cent. Crescendo Advisors, who are often looking to help sell a company, own 10 per cent. It has no debt and about $10 million cash. Revenue grew 17 per cent in the last quarter, to $18.4 million. EBITDA rose 33 per cent and the company is buying back stock. Based on forecasts, it trades at 15X earnings.
If you noticed, most of the companies listed here have no debt and are profitable. A couple of them pay very nice dividends. So yes, they are small, but with a dividend and a clean balance sheet, and profitability, they may not be as risky as you might think. Yes, their stock prices may fluctuate more than, say, a Canadian bank stock. But we think most investors will find them way more fun, and — if things work out — way more profitable.