The greatest share price gains are often made by spotting companies at an early stage of earnings recovery, the scale of which is being materially underestimated by the market.
That was certainly the case with small-cap niche packaging engineering business Mpac when I suggested investors were underestimating both the likely pick-up in second-half orders as lockdown restrictions eased (thus reducing the 2020 profit shortfall) and potential for a stronger than forecast earnings rebound in 2021 (‘Deep value buys’, 13 July 2020). That call has played out neatly, which is why Mpac’s share price has almost doubled even though its pre-tax profit declined by ‘only’ 16 per cent in 2020, far less than pessimists had been factoring in. The other dynamic I feel is likely to come into play is earnings multiple expansion as more investors cotton on to Mpac’s robust growth prospects and higher levels of profitability as operating margins expand. With the shares rated a third below sector peers on a price/earnings (PE) basis, that is simply not in the price.
Corporate broker Cenkos Securities is another recovery play that’s exhibiting similar characteristics. At the current entry point, the shares are priced for a highly profitable outcome, too.