In recent years, the small- and mid-cap areas of the UK stock market have really underperformed. As a result, a lot of smaller British growth stocks look cheap right now.
One stock that looks interesting to me is video game services specialist Keywords Studios (LSE: KWS). According to analysts at Deutsche Bank, it has the potential to rise 89% from its current levels.
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An undervalued AIM stock
I’ve owned this AIM-listed growth stock in the past. And I’ve done very well from it. Back in October 2019, I bought some shares in Keywords Studios when they were trading around the 1,140p level. Three years later, I sold them at a price of 2,520p, notching up a gain of about 120%. That translates to an annualised return of about 30%.
Looking at the stock today, I’m surprised to see that it’s back at 1,310p. At that share price, the company’s forward-looking price-to-earnings (P/E) ratio is only 12.4. That seems very low to me, given that Keywords’ revenue is forecast to rise by about 16% this year.
It seems Deutsche Bank’s analysts agree with me. On 9 May, they initiated coverage of the stock with a Buy rating and a price target of 2,470p.
In a growth industry
One thing I like about Keywords is that it operates in an expanding industry. According to the company, industry forecasts point to continuing long-term growth in the video gaming market, with growth in the content creation segment expected to be above the overall market. External service provision – which Keywords specialises in – is expected to be the fastest-growing segment, with a five-year compound annual growth rate (CAGR) of over 9%.
On the downside, the video gaming market can be cyclical at times. For example, after a few strong years, the market was mixed in 2023 as game publishers focused more on profitability than on taking risks around new content. This led to an increase in the number of games being delayed or cancelled.
Improving market conditions
Looking at the company’s recent results, however, management appears to be relatively optimistic in relation to the medium-term outlook.
“As we move into 2024, we expect a gradual improvement to market conditions and we remain confident in the medium-term market backdrop,” said CEO Bertrand Bodson.
“We expect to deliver strong revenue and profit growth and further extend our market leadership position in 2024,” he added.
It’s worth noting here that the company increased its dividend by 10% in its full-year results. A dividend increase of this magnitude is generally a signal that management is confident about the future.
Given management’s commentary and the dividend increase, there may be an opportunity to consider right now.
AI risk
The big risk with this stock, in my view, is generative artificial intelligence (AI).
This technology can do a lot of amazing things today, including a lot of things Keywords has traditionally done for its customers like video game artwork, translation, localisation, and marketing.
So, there’s some uncertainty in relation to Keywords’ future revenues. Looking ahead, we could see game developers doing more work in-house.
I reckon a lot of uncertainty is priced into the stock already though. At a P/E ratio of 12.4, I think this growth stock is cheap today.
