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5 Small Cap Stocks for Punters

5 Small Cap Stocks for Punters

By Tony Featherstone 31.08.2015


An investment commentator this week likened the sharemarket correction to a department store sale. With the Australian sharemarket down 14 per cent from its most recent peak, it was time to go “bargain hunting” because stocks offered better value.

That is simplistic, dangerous advice. Confusing value and price, and anchoring expectations to past prices is a surefire way to destroy capital. The market, expensive when it flirted with 6,000 points earlier this year, is now fairly valued after the correction. It’s no bargain.

Like a department store sale, lower-quality stocks that have less demand usually get marked down the most. The stocks you want attract less of a discount, or none at all. So instead of focusing on the bargain bin, stick to the quality names that hold more of their price.

In this market, the quality companies are those with reliable prospects to grow faster than the economy. Amid softening global and Australian economic growth, investors are paying a higher valuation premium than usual for companies that can maintain higher growth.

These stocks have recurring themes: capital-light business models that allow them to grow with huge extra investment; an ability to fund growth internally; recurring or annuity-like revenue; high profit margins; a rising proportion of offshore earnings; a high and rising Return on Equity; and an “economic moat” or barrier to entry around their operation.

These stocks typically reinvest heavily in the business to fund rapid expansion, and can wind back their investment should growth slow. Think Seek, REA Group, Carsales.com and other disruptors with capital-light business models and dominant industry positions.

These are the companies to look for during market corrections, when stocks are indiscriminately sold. They won’t make the bargain bin because smart investors hold on to them. But the correction can still provide a better entry point.

Here are five small-cap stocks that fit some or all of the above criteria and are worth considering during this sharemarket correction. As small-cap stocks, they suit investors comfortable with higher risk.

1.  iProperty Group

The online property advertising group has fallen from a 52-week high of $3.57 to $2.85, and dropped about 10 per cent during the market sell-off in August. iProperty dominates the  online property advertising market in Malaysia and now in Hong Kong after buying REA Group’s real estate portal, squarefoot.com.hk, late last year.

It has strong organic growth prospects: online property advertising in Malaysia and Singapore is less than 10 per cent of the total property advertising and 3 per cent or less in Hong Kong, Thailand and Indonesia.

Chart 1: iProperty Group

Source: The Bull

2. iSentia Group

The print and social-media monitoring provider has fallen from $3.85 in late July to $3.25, despite beating prospectus forecasts for underlying earnings in its recent profit result. It also acquired King Content, a leading full-service content marketing company.

iSentia is expanding rapidly in South-East Asia and Greater China through acquisitions and organic growth, and is ideally positioned as explosive growth in social media leads to more companies needing media-monitoring services.

Chart 2: iSentia Group

Source: The Bull

3. iSelect

The policy-comparison company rose strongly during July and has held up well in August, despite the market sell-off. It had a terrible start to life as a listed company after its 2013 float, but has soared from $1.20 earlier this year to $1.70, and is heading towards the $1.85 issue price.

iSelect is benefiting as about a quarter of health-insurance policies are bought via aggregator sites and as 80 per cent of younger health-fund members buy their policy online. iSelect’s move into life insurance could shake up that segment of the market.

New management that is focused on cash flow through a revised business model that relies more on upfront, rather than trailing, commissions, is another plus for iSelect. It could be a takeover target for a large UK or US aggregator of insurance policies.

Chart 3: iSelect

Source: The Bull

4. Freelancer

The micro-jobs platform had a rollercoaster ride after listing in November 2013. After raising $15 million at 50¢ a share in an IPO, Freelancer soared to $2.50 on debut and slumped to 65 cents earlier this year. It rallied to $1.52 this month, before retreating to $1.24.  

That provides a better entry point to buy one of the market’s genuine industry disrupters.

Freelancer is building a strong position in the global micro-jobs market, where Western companies typically recruit service workers in emerging markets for projects at lower cost. The long-term trend towards freelance work – one in three workers in the United States is now a freelancer or contractor on some estimates – shows no signs of slowing.

Chart 4: Freelancer

Source: The Bull

5. NextDC

The data-storage group has barely missed a beat during the market correction. At $2.52, it is trading just below its 52-week high and is further evidence that better-quality stocks hold more of their price during corrections.

NEXTDC is a lower-risk play on the cloud-computing boom. It has a valuable early mover advantage in data storage and management, having built state-of-the-art data centres in Sydney, Melbourne, Brisbane, Perth and Canberra.

It has been growing storage capacity and tenancy levels and the trend towards cloud-computing and outsourced data storage and maintenance is still in its infancy.  The long-term potential is building a large base of annuity revenue and expanding overseas.

Chart 5: NextDC

Source: The Bull

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week's newsletter

 

Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at August 25, 2015.



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