We all know that investing in small-cap companies can be hugely rewarding, both for your bank balance and your ego. It’s always more satisfying to brag about the multi-bagging hidden winners you’ve unearthed than it is to talk about single-digit dividends you’ve earned from investing in steady-yet-boring blue-chips.
Adventurous small-caps
Much depends on your personality. If you’re willing to stomach the potentially devastating losses that can be incurred when investing in small-caps, then good for you, but small-cap investing isn’t for everyone. Personally I’ve always championed the idea of building a well-diversified portfolio comprising a nice balance of defensive blue-chips and more exciting and adventurous smaller firms. But as always, if you want to retire early, you have to pick the right stocks.
Many of London’s smaller listed companies have yet to prove themselves by actually turning a profit, let alone showing signs of long-term growth potential. And that’s particularly true of the junior AIM market, where many oil & gas exploration, mining and pharmaceutical minnows are nothing more than highly speculative bets. But if you’re willing to dig deep enough, there are plenty of quality businesses just waiting to be discovered.
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Ninefold increase
Take Renew Holdings (LSE: RNWH) for example. The AIM-listed engineering services group has not only proven it can turn a healthy profit, but has grown its market capitalisation more than ninefold since September 2005 without recourse to new equity.
The Leeds-based group operates a number of autonomous subsidiary businesses which provide essential engineering services to maintain and renew UK infrastructure networks. These independently branded businesses have expert knowledge in their individual markets and directly deliver engineering services aligned to the needs of clients, many of whom are responsible for the long-term maintenance and renewal of national infrastructure networks.
Strong results
In its last completed financial year, the group delivered another strong set of results reflecting the company’s position as a leading provider of engineering services to many of the UK’s critical infrastructure assets and in particular the nuclear, rail and water markets.
Group revenue (including £2.2m from a joint venture) increased by 6.7% to £560.8m, with adjusted pre-tax profits up 13.1% to £25.2m, compared to £22.3m reported for the year before. At the end of the 2017 financial year, the group’s order book stood at a healthy £511m, with a net cash position of £3.9m after the acquisition of Giffen Holdings for £7.2m during the year.
High barriers to entry
Renew’s share price has enjoyed spectacular growth over the past decade or so, but I think there’s plenty more to come from this £250m small-cap . The regulated markets in which the company operates have high barriers to entry and, alongside the group’s extensive expertise in delivering asset care and maintenance, provide strong opportunities for long-term growth.
I believe the recent sell-off is unjustified with management confirming it has no financial exposure to Carillion. Herein lies a good opportunity for contrarians to buy on weakness at just 10 times current year earnings. Income seekers may turn their noses up at the relatively modest dividend yield of 2.7%, but payouts are covered more than three times by forecast earnings, leaving plenty of room for hefty hikes in the future.
