A lot of decent AIM stocks have been crushed in the last few years. So this area of the London Stock Exchange could potentially throw up some lucrative investment opportunities in the years ahead.
One stock I like the look of right now is Gamma Communications (LSE: GAMA). According to analysts at Deutsche Bank, it has the potential to rise more than 50% from here.
An undervalued stock
For quite a while now, I’ve thought this stock is undervalued.
A provider of business communication solutions, Gamma is a high-quality company.
Not only does it have a great track record when it comes to growth (five-year sales growth of 183%) but it also has a high return on capital employed (meaning it’s very profitable).
Yet today, its forward-looking price-to-earnings (P/E) ratio is just 18, which is a relatively low earnings multiple for a high-quality tech company.
50% gains?
I think the company deserves a higher valuation. And it seems analysts at Deutsche Bank agree with me. On 3 May, they initiated coverage of the stock with a Buy rating and a 2,250p price target. That’s roughly 51% higher than the current share price.
If the analysts are right, a £2,000 investment in Gamma shares could soon be worth over £3,000.
Why I’m bullish
It may not, of course, but one reason I’m bullish on Gamma is the digital transformation theme. Across the UK and Europe today, businesses are rushing to get fit for the digital age. And Gamma is benefitting from this trend.
It offers a broad range of services that are pretty much a must-have for companies today including internet access, cloud-based phone systems, and collaboration tools. And it can serve businesses of any size.
The opportunities which lie ahead of us suggest a promising future for the group.
Gamma Communications CEO Andrew Belshaw
I also like how profitable this company is. Over the last five years, return on capital employed has averaged 23.2%.
A high return on capital is one of the first things I look for in a stock. That’s because over the long run, it tends to lead to strong company growth and big returns for investors.
Additionally, I like the capital returns to shareholders. Back in March, the company hiked its dividend by 14%. That large increase in the payout suggests management is confident about the future.
On top of this, the company announced a £35m share buyback. This should help to boost earnings per share.
I’m excited
Now, the big risk with this stock is the UK economy. If economic conditions were to deteriorate from here, small- and medium-sized businesses could struggle. This could reduce the level of spending on this type of technology.
Another risk to consider is acquisitions. Recently, Gamma has made a few of them. They may not go to plan.
All things considered however, I think this stock has a lot of appeal. As an investor in the firm, I’m excited about the potential over the next 12-24 months.
