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Operationally geared for outperformance

Two small-cap technology companies offer operationally geared business models, and are also benefiting from strong end market demand
Operationally geared for outperformance

I write a fair amount about operationally geared companies, and with good reason.

That’s because once a business reaches the inflexion point whereby its gross margin earned covers all fixed operating costs, then a high percentage of the incremental gross margin earned on additional sales will drop through to operating profit after deducting variable costs incurred. Operating profits will then race higher and outpace revenue growth as the operational leverage of the business kicks in. Of course, one needs to identify companies capable of generating the requisite turnover growth in the first place.

The technology and healthcare sectors are good hunting grounds. That’s because many companies in this space sell patent-protected high-margin products that offer tangible benefits to customers. Most are not labour intensive, either, so incremental costs associated with generating additional sales are relatively low. In particular, I look out for cash-rich companies trading on modest sales multiples, thus providing attractive entry points assuming of course they can achieve a decisive move into profit. Building a decent recurring revenue stream is one way of doing so.

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