Although small-cap stocks are considered riskier investments than their large-cap counterparts, they also often offer the potential for larger gains. This is because smaller companies tend to be more commonly mis-priced by the market due to behavioural biases and their perceived business risks, enabling investors to occasionally find some hidden gems.
If you’re looking for the next diamond in the rough, then consider these two under-the-radar picks.
Market leader
First up is Strix Group (LSE: KETL), a company which designs and manufactures kettle safety controls, thermostats and water boiling elements for domestic appliances.
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While many of us may never have heard of the company before, Strix is a worldwide market leader, supplying 38% of the global kettle market with its proprietary water temperature management sets. It’s not a particularly exciting, fast-growing industry, but Strix does appear to be finding healthy profits in a niche market.
For the six months to 30 June, the company generated revenues of £42.2m, with pre-tax profits of £10.3m — an increase of 9.6% on the £9.4m figure earned in the same period last year. Encouragingly, export sales have been particularly strong, with the firm gaining market share in emerging markets.
With growing scale and a widening lead over its competitors, Strix is well-placed to leverage its strong pricing power and improve on its already impressive first-half EBITDA margin of 33.6%. As such, investors should not only expect meaningful bottom-line growth going forward, but also some multiple expansion as well.
The company, which was founded in 1982, has only been listed on London’s Alternative Investment Market (AIM) since August this year. But despite the short span of time, investors who backed the 100p-a-share initial public offering (IPO) are already sitting on big gains, as the shares are now priced at 138p.
Still, I reckon further gains could still be to come as valuations remain undemanding. At its current share price of 138p, Strix is valued at less than 12 times its annual earnings and offers a prospective dividend yield of 5.1%.
Technology disruption
Elsewhere, Xeros Technology (LSE: XSG) is an exciting small cap-pick for investors looking to bet on innovative, environmentally-friendly technologies that have the potential to disrupt existing industries & practices.
Xeros’s patented polymer based technologies, which use less water and energy compared to conventional tech, is a potential game-changer in three world-scale industries: cleaning, tanning and textiles. A Xeros commercial laundry machine replaces water with millions of reusable polymer beads, reducing water use by up to 75% when compared to a traditional laundry machine.
The company is still some way away from delivering significant profits, as the firm today reported a widening in its H1 after-tax loss, to £15.1m, following a ramp-up in its commercialisation programme and higher research and development costs. On the upside, Xeros’s total installed estate of commercial cleaning machines increased by 36% to 378 machines, reflecting robust demand and growing acceptance of the technology.
Furthermore, Xeros plans to demonstrate its domestic machine prototype design at the Consumer Electronics Show in January next year, which would be a major boost to the company’s future expansion plans, as it would widen the potential applications of its tech to a much wider market.
