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Foolish Small Cap update

Created:

6 May 2008

Written by:

David Stevenson

This is a pure growth screen for small cap investors – that makes it high risk but it can also produce some stunning returns. It aims to find shares that are below the radar of most big City analysts.

The first screen

• RS in the last three months is in the top quartile for the market.

• The net profit margin must be in the 10 – 15% range

• A share price that is more than 10p. This is designed to avoid the difficult to trade and highly volatile penny stocks of old (daily trading volumes can also be very low)

• Market cap should be in the £10 to £100m range

• Earnings per share over the last 3 years should be at least 10% per annum and earnings for the current year should be growing by at least 20% over the year

• ROCE above 10%.

The second screen is much more qualitative and looks at more company specific issues.

• Sales growth at the top line should be at least 25% in the last year

• There should be strong evidence of 'insider ownership' – management – with a suggested minimum of 10% of the entire equity

• ROCE of 15% should be present for at least the last two years

• A sales maximum of £500m. In practice this could easily be set lower – at around £200m.

• Make sure that the cashflow at the operating level can easily pay for capex and dividends.

WATCH out for...

• Insider Ownership – 10% equity or more

• Cash inflow must pay for capex AND dividend

• RS top quartile last 3 mths

• EPS growth last 3 years above 10%

April was an unkind month for recruitment software company Dillistone – its shares have continued to slip back and overall its now down just over 16%. We can't quite understand why the market has reacted in this way considering recent results which showed a very trading result. In the middle of April it posted a 30 percent rise in its full-year pretax profit on higher revenue and said it has a strong platform to continue to develop in 2008, despite the economic uncertainty seen recently in world markets. For the year ended end-December 2007, its pretax profit rose to £1.20 million pounds from £0.92 million last year while revenue grew 23 percent to £4.07 million pounds, with cash at bank rising from £0.54m to £1.53m. It also posted a positive trading outlook noting that "our strong balance sheet and substantial cash reserves at the year end, together with the increasing value of recurring revenue contracts means that the group is relatively well protected against any short term slowdown in economic activity." The portfolio has also been hurt by the recent drop back in the share price of TMN – one bidder (Tangent) has withdrawn and a recent trading statement pointed out that a division working in the financial services division was having a hard time. We're certain there will be more bids on the way and that trading statement was absolutely not a profits warning, so stick with TMN. There are no other changes to the portfolio this month.

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