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Three genuine value small-caps

My genuine value small-caps screen now boasts a two-year total return of 53 per cent compared with 16 per cent from the market
June 23, 2015

The past 12 months have been tough for small-caps and especially shares traded on the Alternative Investment Market (Aim). That's been reflected in the performance of my genuine value small-caps - 60 per cent of which hailed from Aim - over the past 12 months. Overall, the 20 stocks selected by the screen last year have managed to produce a decent level of outperformance (see table), which builds on a strong first year. Indeed, the 4.1 per cent total return from last year's stock picks compared with 2.1 per cent from a 50:50 blend of the FTSE Small Cap and Aim, taking the cumulative return from the strategy over the past two years to a hearty 53.5 per cent, compared with 16.4 per cent from the market. If a 1.75 per cent charge is added in to reflect the high costs associated with dealing small-caps, the total return for the two years falls to 48.0 per cent.

NameTIDMTotal return (9 Jun 2014 - 15 Jun 2015)
Finsbury FoodFIF60%
Dart GroupDTG48%
EmpresariaEMR42%
NovaeNVA40%
Renew HoldingsRNWH29%
Laura AshleyALY20%
James CropperCRPR17%
Brooks MacDonaldBRK14%
T ClarkeCLRK7.7%
MacfarlaneMACF6.9%
TrifastTRI1.4%
LamprellLAM-3.5%
Journey GroupJNY-4.1%
Impax Asset ManagementIPX-6.7%
Mission Marketing GroupTMMG-8.7%
MP EvansMPE-9.4%
Charlemagne CapitalCCAP-22%
DialightDIA-38%
Amiad Water SystemsAFS-45%
Pressure TechnologiesPRES-67%
Genuine Value Small Caps-4.1%
FTSE Small/Aim-2.1%
FTSE SMALL CAP - TOT RETURN IND-7.1%
FTSE AIM ALL-SHARE - TOT RETURN IND--2.9%

 

 

While the overall outcome for the past 12 months was one of modest outperformance, on a stock-by-stock basis there was some real drama. Some stocks, such as Pressure Technologies, tanked while others, such as Finsbury Foods, soared. Extremes in share price performance are characteristic of small-caps and should be expected when investing in this part of the market, especially when picking stocks through screening processes which struggle to be all that nuanced.

The screen uses my genuine value (GV) ratio as its primary stock picking criteria. The GV ratio can be thought of as a price-earnings growth (PEG) ratio adjusted to take account of a company's net debt and dividends paid. To take account of net debt the ratio focuses on enterprise value (EV), which is a company's market cap minus its net debt. As the formula uses EV, the earnings figure EV is compared with also needs to be adjusted for any interest paid on net debt. This means the ratio looks at earnings before interest and tax (Ebit, or operating profits) rather than post-tax profit (PTP or EPS when divided by shares in issue). The formula looks like this:

The GV Formula:

(EV/Ebit) / (dividend yield (DY) + average forecast earnings growth for the next two financial years)

The formula relies on brokers' consensus forecasts, which are unreliable at the best of times but can be particularly off-target for small-caps due to the limited amount of scrutiny the sector gets and the susceptibility of these businesses to outside factors and relatively minor commercial developments. The screen tries to eliminate earnings forecasts that could prove too outlandish or that are inconsistent from one year to the next. The screen also looks for shares showing decent momentum, as an indicator that the market has some faith in the investment case behind the shares in question. The full screening criteria is:

■ A GV ratio among the 'cheapest' quarter of stocks screens.

■ Three-month momentum better than the median average for all stocks screened.

■ Growth forecasts of less than 100 per cent for each of the next two financial years.

■ Forecast growth rate must not drop by more than 50 per cent between the next year to be reported on and the following year.

In total, 25 stocks made it through the screen this year. I've focused on three of them in my write-ups below based on the stock with the lowest GV ratio, the stock with the best average forecast EPS growth rate over the next two financial years, and the stock showing the strongest three-month momentum. The rest of the stocks appear in the table that follows, which is ordered from lowest ('cheapest') to highest GV ratio.

 

Three genuine value small-cap highlights

Gulf Marine Services – Lowest GV ratio

The oil services sector is an obvious place to look for value at the moment but not such an obvious place to look for growth. But despite the decline in the oil price and the knock-on effect for the oil and gas industry's spending plans, Gulf Marine Services (GMS) is indeed forecast to produce strong growth over the next two years. One factor behind these broker predictions is that Gulf Marine serves relatively defensive end markets as most of the offshore vessels it rents out are hired by National Oil Companies (NOCs) in the Gulf states. NOCs are considered to be reliable clients, which should be more consistent in their capital spending plans than smaller private sector oil players.

While Gulf Marine's client base is defensive, growth expectations are being fuelled by its expansion plans. By the time its 2014-16 investment programme is complete, Gulf Marine's fleet size should have increased by two-thirds. What's more, utilisation rates remain impressively high, riding at 95 per cent at the end of the first quarter of 2015, and the company says charter day rates remain at "good levels". Prospects are also supported by a secured work backlog of $685m (£433m).

On paper, based on current consensus forecasts, Gulf Marine looks an absolute bargain. But belying this is considerable market uncertainty about the outlook for any business serving the oil and gas industry, which includes a company like Gulf Marine that has a relatively reliable customer base. A key question is whether Gulf Marine can preserve its hire and utilisation rates. But, from this screen's point of view, this is a risk worth taking, which was also the basis of a recent IC buy tip on the shares.

Last IC view: Buy, 125p, 28 May 2015

 

Solid State – Highest forecast growth

There will be strong growth in profits when ruggedised-computers specialist Solid State (SSP) reports on the year to the end of March on 7 July, as the benefits of its three-year, £34m electronic-tagging contract with the Ministry of Justice (MoJ) start to show through. However, the really big year will be 2016, when broker WH Ireland expects EPS to soar to 56p compared with the 32.7p it expects from the recently completed 12-month period and 28.5p the year before that.

The MoJ contract has transformed the earning potential of Solid State's business, although, having one such significant contract means there is a lot riding on the company's ability to deliver on its client's expectations and win a renewal at the end of the contract period. But if the group does impress the MoJ and the wider market with its handling of the work, it will put itself in a strong position to bid for other major contracts.

Meanwhile, Solid State continues to develop the rest of its business. It recently announced the £2.1m acquisition of Ginsbury Electronics, to strengthen its Solid State Supplies business. And earlier this month the group reported a £1m-plus contract with Renishaw. Dividend growth is also set to step up a gear thanks to a lowering of the company's targeted dividend cover from three times to 2.5 times, which was announced last year. On this basis, WH Ireland is forecasting a 20p 2016 dividend payment, equivalent to a 2.3 per cent yield.

Last IC view: na

 

Red24 – Most 3-month momentum

One of the most enticing things about micro caps is that their share prices can surge in reaction to events that would represent minor news for larger companies. That's what happened to shares in crisis management specialist Red24 (REDT) earlier this month when it reported that would provide clients of Swiss insurance giant Allianz with services for responding to product contamination, hostile environment and terrorism risks. The association with such a big name as Allianz gives credibility to the global network of specialists that Red24 has set up to offer support for technical, testing, regulatory, logistical and crisis communications.

The Allianz news followed on the back of well received results. Thanks to new contract wins, the group managed to marginally increase turnover despite the loss of a major contract. While the loss of the contract was a blow, management has also pointed out that the reduced reliance on a single large client has removed a major risk that had previously hung over the business. Meanwhile, cost cutting helped send full-year pre-tax profits up by a quarter and the dividend got an 11 per cent boost.

Red24 has also been warming to the potential for acquisitive growth and recently bought a business in Singapore to boost its presence in the region and to bring it new blue-chip clients. The strong balance sheet should provide scope for further growth-focused deals. The company has also been investing in its travel tracker product, launched in February, which it believes has significant potential.

Last IC view: na

 

NameTIDMMkt capPGV RatioFwd NTM PEDYFwd EPS grth FY+2Fwd EPS grth FY+23-mth MomNet Cash/ Debt (-)
Gulf Marine Services GMS£430m123p0.2871.2%17.7%29.9%6.1%-$274m
Globo Aim:GBO£224m60p0.327-21.8%13.6%6.9%€40m
City of London Investment  CLIG£87m350p0.36136.9%28.5%19.4%6.0%£12m
Martinco Aim:MCO£29m132p0.37144.1%31.1%28.9%7.3%£1m
red24 Aim:REDT£11m24p0.40112.3%19.8%11.4%47.2%£3m
RTC  Aim:RTC£10m70p0.42102.9%25.9%18.5%7.7%-£3m
Morgan Sindall  MGNS£366m840p0.42143.2%31.6%17.5%11.0%£52m
OPG Power Ventures Aim:OPG£362m103p0.4313-50.1%30.9%10.7%-£253m
Utilitywise Aim:UTW£210m275p0.51161.5%26.2%32.1%31.3%£2m
Mothercare MTC£443m260p0.5427-15.1%48.2%37.1%£32m
Highland Gold MiningAim:HGM£159m49p0.5458.2%2.4%9.7%40.0%-$247m
H&T  Aim:HAT£71m195p0.55132.5%24.9%13.5%7.9%-£9m
SThreeSTHR£475m373p0.56203.8%25.0%20.2%13.3%-£10m
Carclo CAR£101m153p0.57151.8%30.9%16.6%13.8%-£25m
Liontrust Asset Management LIO£121m282p0.62121.4%31.2%20.5%7.2%£14m
Empresaria  Aim:EMR£29m66p0.6271.1%10.6%7.7%13.9%-£10m
Solid State Aim:SOLI£71m858p0.64271.0%25.4%57.0%29.9%-£1m
Dart  Aim:DTG£602m409p0.68160.7%6.7%8.1%11.1%£322m
Matchtech  Aim:MTEC£168m548p0.68133.7%15.6%13.2%4.8%-£2m
NAHL  Aim:NAH£137m332p0.70126.4%12.5%8.3%22.2%£8m
Creston CRE£80m137p0.71103.1%5.0%8.9%17.3%£8m
Lifeline ScientificAim:LSIC£34m173p0.7119-16.7%37.3%27.8%$1m
Hayward Tyler  Aim:HAYT£36m80p0.73111.9%13.7%8.3%8.8%-£8m
Sirius Real Estate Aim:SRE£339m46p0.73173.7%32.3%19.0%7.7%-€237m
Robert Walters RWA£293m400p0.78241.5%20.2%13.4%10.6%£14m

Source: S&P CapitalIQ