However, in this unforgiving trading environment there are still investment opportunities worth capitalising on. In particular, those where investors have become too risk averse and share prices fail to acknowledge by some measure the intrinsic value in special situations. To a large degree, this approach to stock picking has been the one I have adopted over the past six months. Despite being wrong footed on some investments, a large number of winners have racked up bumper gains and no more so than in the technology sector. It's well worth recounting why these have worked out in order to focus the mind on replicating the success in the future. I also have to decide on whether to bank profits now that a number have hit my target prices.
Stadium of light fantastic gains
Shares in Aim-traded Stadium Group (SDM:123p), a specialist provider of niche electronic technologies, have soared 64 per cent since I initiated coverage 75.5p less than six months ago ('Switch onto the Stadium of light', 30 July 2014). Having seen my initial target price of 105p hit last autumn, I reviewed the investment case and upgraded my fair value target at the time to 120p ('Exploit a repeat buying opportunity', 2 October 2014). That target was hit last week.
In my view, the reasons why Stadium's shares have performed so well, during a period when the FTSE Aim index has fallen by 9 per cent, are three fold. Firstly, the company's future earnings growth profile was robust when I initiated coverage and still is - the board talked of a strengthening order book and a strong second half in their latest trading update - and was clearly achievable. Factoring in the benefits of acquisitions, and cost savings, analysts at brokerage N+1 Singer predict that the company will deliver a 50 per cent plus rise in pre-tax profits in 2014 and the same again in fiscal 2015. On this basis, expect EPS to rise from 5.1p in 2013, to 6.9p in 2014 and 10.5p this year, so a single digit prospective PE ratio was appealing in light of the earnings growth expected. Even now the forward PE ratio is only 12.
Secondly, the company has sound finances sound and, with the benefit of cashflow from acquisitions, a significant hike in the dividend can be expected: the board increased the interim payout by 55 per cent to 0.7p a share, and analysts expect a final dividend of 1.4p a share when Stadium reports its full-year results in March. Importantly, income investors will have been attracted by the prospect of another increase in the total payout this financial year too: analysts predict a payout of between 2.5p to 2.7p a share.
Thirdly, the valuation was modest enough to create a margin of error at an entry point of 75.5p even if Stadium failed to fully deliver on anticipated earnings growth assumptions. The fact that it looks well on course to achieve these earnings has given confidence to investors and has meant its anomalous rating discount to the wider electronics sector average of 15 times earnings has narrowed. My advice now is to run your bumper profits ahead of the next trading update in March.
Investors accumulate Accumuli
It took time for the share price of Aim-traded Accumuli (ACM: 32.25p), the independent specialist in IT security and Risk Management, to gain traction but investors have clearly been warming to the investment case. I initiated coverage when the price was 23p ('Profit from cyber warfare', 23 April 2014), and last reiterated the advice at 24p seven weeks ago ('Small cap trading updates', 26 November 2014). The price has now achieved my target price range 30p to 33p.
The main reason for the rerating is that investors are becoming far more aware of the increasing demand for Accumuli's products and services, a fact that I thought was likely when I initiated coverage. Moreover, given the attractive earnings multiple at the time, an above average growth profile and potential for new business wins to deliver additional earnings growth had not been priced into the company's valuation. This anomaly is now correcting itself.
For instance, in late November, the home secretary announced plans in parliament under the updated Counter-terrorism Bill to introduce an obligation on internet service providers (ISPs) to maintain records of internet address allocation matching. The aim of the Bill is to ensure that ISPs are able to provide, when requested, information to national security and law enforcement agencies' datasets that can be used to identify device usage against associated IP addresses. This requirement has the potential to place significant technical and financial challenges on organisations that need to comply and as a result offer potential new business for IT security providers such as Accumuli. The company's proprietary DDAM software can deliver on the new statutory requirement with minimal overhead, can handle vast amounts of data, and is quick to deploy. More importantly, it's not going to break the bank for the ISPs. Accumuli has since then announced a raft of contract wins worth £600,000 in gross profit in the current fiscal year, including another one for its DDAM service.
Investors have also been warming to last month's acquisition of RandomStorm, an integrated information security specialist with its own IP which provides scalable managed security services and risk assessments. It's not only a sound strategic fit enabling additional cross-selling opportunities into Accumuli's existing client base, but the debt-funded structure of the £8.9m acquisition means it has led to significant earnings upgrades. RandomStorm generated £1m of cash profits in its last financial year on turnover of £3.5m and has a high recurring revenue base, so financially it's a good business to invest Accumuli's £3.5m net cash pile in.
Factoring in the contribution from the acquisition, head of equity research Andrew Darley at broking house finnCap predicts Accumuli's pre-tax profits will rise from £3.4m in the 12 months to end March 2015 on revenues of £22.4m, up from £2.5m and £16.6m in fiscal 2014, to £4.3m and £27m, respectively, in fiscal 2016. On this basis, EPS increases from 30 per cent to 1.7p in the 12 months to end March 2015 and by a further 23 per cent to 2.1p in fiscal 2016.
True, Accumuli's shares have rallied strongly, but I still think there is potential to eke out some more gains here. Underpinned by a prospective dividend yield of 2.1 per cent, rising to 2.8 per cent in fiscal 2016, and rated on a forward PE ratio of 16, the shares are trading on a discount to other small cap software companies: Tracsis (TRCS:427p), Craneware (CRW:500p) and Netcall (NET:70p) are all rated on 20 times earnings or above. The average dividend yield for the FTSE Aim technology index is a meagre 0.5 per cent, or less than a quarter of the yield offered by Accumuli. In the circumstances, I don't think that finnCap's raised target price of 36p is out of place and if you followed my advice I would run your 35 per cent gains.
Amino fires the ammunition
Aim-traded Amino Technologies (AMO:122p) is a Cambridge-based set-top box designer of digital entertainment systems for IPTV, home multimedia and products that deliver content over the open internet. I first advised buying at 83p ('Set up for a buying opportunity', 10 June 2013), and updated my view when the price was 112p ('Wired up for gains', 11 November 2014). The shares subsequently achieved my year-end target price of 120p, hitting a nine-year high of 132p last month.
Earnings upgrades driven by increasing demand from customers are always positive and in the case of Amino this has been a key driver of the rerating. Indeed, when the company reports its full-year results on Monday, 2 February, the announcement is set to make for a rather good read. Post a bumper pre-close trading update last month, analyst Andrew Darley at broking house finnCap upgraded his EPS estimate from 7.4p to 7.8p for the 12 months to end November 2014, up from 6.3p in 2013. He has also upgraded his fiscal 2015 forecast by over 10 per cent to 8.2p.
A forward PE ratio of 15 may seem fair, but this ignores Amino's robust cash generation and bumper cash pile: net funds of £20.8m equate to 40p a share. This means with net cash accounting for a third of the company's share price, Amino shares are in effect trading on only 10 times fiscal 2015 earnings estimates. There is a very progressive dividend policy too: Amino's board has committed to raising the dividend by at least 10 per cent for the next two financial years. Analysts at Northland Capital predict a payout of 4.56p for the 2015 fiscal year, up from 4p, implying a prospective yield of 3.7 per cent.
The combination of strong contract momentum, double digit earnings growth, robust cash generation, earnings enhancing share buy backs, and a progressive dividend policy all make for an attractive investment case. Ahead of the forthcoming results, I would run your 44 per cent gains as another positive trading update from the company could easily send the shares back to that 132p price high, and beyond. finnCap has a target price of 150p. Run profits.
Netcall's dials the right numbers
Shares in Aim-traded shares in Netcall (NET:71p), a small-cap business offering software to make telephone call-handling more efficient, have surged back to a 14-year high and my target price of 70p ahead of a pre-close trading statement later this month and half-year results in late February.
The lesson to learn here is that it pays to run gains where a company has a cash generative business with high recurring revenues and one generating organic growth as it offers scope to recycle excess cash into making earnings enhancing bolt on acquisitions, while rewarding shareholders with strong dividend growth. In fact, since I initiated coverage four years ago when the shares were priced at 13p ('Queuebusters', 17 January 2011), Netcall has grown from a company making pre-tax profits of £1m on revenues of £4.1m to one that analysts expect to report pre-tax profits of £5m on revenues of £17.9m in the 12 months to June 2015. And with cash flow robust, expect net funds to rise to £13.7m by the financial year-end, or the equivalent of 10p a share.
Investment in new products and exploiting cross selling opportunities across Netcall's 700-strong client base has clearly helped generate this growth as has a raft of new customer wins, a theme that has been prevalent in the time I have been following the company. Another key feature worth noting is the high level of recurring revenues which improves earnings visibility. Two-thirds of all new business is from existing clients which highlights the importance of a loyal customer base to the earnings multiple investors are willing to pay for a slice of the company. In the case of Netcall, strip out net cash and the shares are now priced on 20 times earnings, a valuation in keeping with a business that continues to win new contracts that are have been driving a near-double-digit rise in underlying revenues. That warrants running profits even though the shares are up a further 16 per cent since I last advised buying ('Income stocks with capital upside', 1 December 2014).
The final point to note is the importance of dividends, a characteristic of all the tech stocks in this article. Netcall offers a well-covered payout: EPS of 2.75p covered the 0.9p-a-share dividend three times over last year and analysts expect a payout of 1p a share in the current financial year, implying a prospective yield of 1.4 per cent. In the 2011 fiscal year Netcall paid a maiden dividend of 0.4p, so the payout has more than doubled in the past three financial years alone.
Robust cash flow generation, high recurring revenues, progressive dividend policies underpinned by strong expected earnings growth and cash rich balance sheets have been features of all the four tech stocks, characteristics well worth making a mental note of in the hunt to replicate this success.
■ Simon Thompson's book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stockpicking'
