Realistically, if you want to latch onto a really big winner on the stock market, you’ve got to buy shares in a company before the growth story is widely known in the investment community. To me, that means hunting for shares with smaller market capitalisations.
When a growth share becomes widely followed, speculation can drive up the valuation so high that any investment you make in the company’s shares can face downside risks brought on by a valuation reversal. And that can happen despite strong operational progress in the underlying business.
New to the stock market and growing fast
I like the look of two small-cap shares and I think they could do well for investors during 2019 and beyond. The first is Filta Group Holdings (LSE: FLTA), which provides cooking oil filtration and fryer management services to restaurants and other food establishments. During 2017, around 72% of the firm’s revenue from continuing operations came from the US and 28% from the UK.
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The company started up around 20 years ago in the UK and has expanded both at home and abroad, organically and through acquisitions. The outlook is bullish and the firm expects to grow further by both methods in the short, medium and long term. Yet despite its long history, Filta only arrived on the stock market with its Initial Public Offering (IPO) at the end of 2016, which I see as another positive. I believe firms can be at their entrepreneurial best and often well-financed when they first go public, which means a strong growth phase can follow. Getting into a share within a short time following its IPO can work out well for investors in some cases.
Decent quality indicators
If you dig into Filta, you’ll find decent quality indicators such as a return on capital running close to 21% and an operating margin at about 15%. There’s also a robust outlook for earnings growth, a reasonable valuation given the firm’s prospects and a handy dividend to collect. Meanwhile, the balance sheet is strong with a decent net cash position. There’s a lot to like about Filta despite its small market capitalisation close to £69m.
The second share I’m keen on has a higher market capitalisation near £118m. Sopheon (LSE: SPE) provides software and services for product lifecycle management. In 2017, around 60% of revenue came from America and 40% from Europe, but 92% of the operating profit was earned across the pond and just 8% from Europe, so America is an important geography for the firm.
Building a blue-chip client base
Sopheon has been making solid progress building up its blue-chip client base and the outlook is positive. Other attractions include a strong balance sheet with a net cash balance and robust quality indicators, such as a return on capital of around 30% and an operating margin running at about 20%.
Although the valuation looks full and fair given the growth on offer, there is a small dividend to keep investors company and a recent history of robust operational and share-price momentum. I think both these companies would sit well in a diversified portfolio aimed at capturing ongoing growth potential.
