5 reasons this could be the perfect small-cap stock

Edward Sheldon takes a detailed look at an under-the-radar company that has bags of potential.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

While small-cap stocks can be more volatile than their larger peers, there’s no doubt that many have the potential to make their shareholders life-changing amounts of money. With that in mind, today I’m taking a closer look at £590m market cap Gamma Communications (LSE: GAMA), an under-the-radar small-cap stock that appears to have considerable potential.

Business Description

Founded in 2001, it is a provider of cloud communications services. The company provides voice, data and mobile services for the business market, and clients include Pret, Itsu and Cathay Pacific. Gamma listed on the AIM market in late 2014 at a price of 187p, and the shares have risen almost 250% in just under three years. However, I think there could be more to come.

Revenue & earnings

The first thing that appeals to me is the company’s financials. Revenue has increased from £131.4m in FY2011 to £213.5m last year, a compound annual growth rate (CAGR) of 10.2%, and adjusted earnings per share since the company listed have risen from 15p in FY2014 to 21.1p last year.

Gamma released its FY2017 half-year report this morning, and unveiled another solid set of results. Revenue for the half year climbed 9.8% to £115m, profit before tax increased 17.9% to £12.5m, and adjusted earnings per share rose 14.9% to 11.6p.

Cash flow

Gamma also appears to be generating plenty of cash flow. The company generated operating cash flow of £26.5m for FY2016, and had a cash balance of £28.2m at year end. Today’s half-year results reported adjusted net operating cash flow of £15.3m, up 10.9% on last year.

Dividend

The strong levels of cash flow have enabled the company to pay a dividend to its shareholders every year since listing. Small-cap stocks aren’t usually associated with dividend payments, however, if a smaller company does pay a dividend, I see this as a huge plus.

A dividend indicates to me that not only is the company generating real cash flow, but also that management is confident that the company is in sufficiently good health to return cash to shareholders. It’s also a sign that management values the shareholders, and is willing to reward them with a share of the profits.

While Gamma’s dividend yield is not high at 1.1%, the payout has risen from 3.95p per share in FY2014 to 7.5p per share last year, and City analysts expect further growth of 10% for this year. The interim dividend was increased by a healthy 12% today, from 2.5p to 2.8p.

Valuation

Analysts forecast FY2017 earnings of 23.7p, which, at the current share price of 669p, places the stock on a forward P/E ratio of 28.3.

While no bargain, that level of P/E suggests to me that investors are willing to pay a premium price for a high-quality company, and I see that as a good thing.

Companies that trade cheaply are often cheap for a reason (think of Telit Communications) and companies that trade at eye-wateringly high valuations (like IQE) leave little margin for error. However, a P/E of 20-30 indicates to me that the market is aware that the company offers growth potential, without a level of irrational exuberance attached to the stock.

Lastly, a glance at the chart shows that the stock is clearly in an uptrend. And as they often say in investment circles, “the trend is your friend.”

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

How’s the dividend forecast looking for Legal & General shares in 2025 and beyond?

As a shareholder, I like to keep track of the potential dividend returns I could make from my Legal &…

Read more »

artificial intelligence investing algorithms
Investing Articles

Could buying this stock with a $7bn market cap be like investing in Nvidia in 2010?

Where might the next Nvidia-type stock be lurking in today's market? Our writer takes a look at one candidate with…

Read more »

Investing Articles

Is GSK a bargain now the share price is near 1,333p?

Biopharma company GSK looks like a decent stock to consider for the long term, so is today's lower share price…

Read more »

Snowing on Jubilee Gardens in London at dusk
Investing Articles

Could December be a great month to buy UK shares?

Christopher Ruane sees some possible reasons to look for shares to buy in December -- but he'll be using the…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

Sticking to FTSE shares, I’d still aim for a £1,000 monthly passive income like this!

By investing in blue-chip FTSE shares with proven business models, our writer hopes he can build sizeable passive income streams…

Read more »

Growth Shares

BT shares? I think there are much better UK stocks for the long term

Over the long term, many UK stocks have performed much better than BT. Here’s a look at two companies that…

Read more »

British Pennies on a Pound Note
Investing Articles

After a 540% rise, could this penny share keep going?

This penny share has seen mixed fortunes in recent years. Our writer looks ahead to some potentially exciting developments in…

Read more »

Silhouette of a bull standing on top of a landscape with the sun setting behind it
Investing Articles

Is the S&P 500 going to 10,000 by 2030? This expert thinks so

One stock market strategist sees animal spirits taking hold and driving the S&P 500 index even higher by the end…

Read more »