5 reasons this could be the perfect small-cap stock
While small-cap stocks can be more volatile than their larger peers, theres no doubt that many have the potential to make their shareholders life-changing amounts of money. With that in mind, today Im taking a closer look at 590m market cap Gamma Communications (LSE: GAMA), an under-the-radar small-cap stock that appears to have considerable potential.
Business Description
Founded in 2001, it is a provider of cloud communications services. The company provides voice, data and mobile services for the business market, and clients include Pret, Itsu and Cathay Pacific. Gamma listed on the AIM market in late 2014 at a price of 187p, and the shares have risen almost 250% in just under three years. However, I think there could be more to come.
Revenue & earnings
The first thing that appeals to me is the companys financials. Revenue has increased from 131.4m in FY2011 to 213.5m last year, a compound annual growth rate (CAGR) of 10.2%, and adjusted earnings per share since the company listed have risen from 15p in FY2014 to 21.1p last year.
Gamma released its FY2017 half-year report this morning, and unveiled another solid set of results. Revenue for the half year climbed 9.8% to 115m, profit before tax increased 17.9% to 12.5m, and adjusted earnings per share rose 14.9% to 11.6p.
Cash flow
Gamma also appears to be generating plenty of cash flow. The company generated operating cash flow of 26.5m for FY2016, and had a cash balance of 28.2m at year end. Todays half-year results reported adjusted net operating cash flow of 15.3m, up 10.9% on last year.
Dividend
The strong levels of cash flow have enabled the company to pay a dividend to its shareholders every year since listing. Small-cap stocks arent usually associated with dividend payments, however, if a smaller company does pay a dividend, I see this as a huge plus.
A dividend indicates to me that not only is the company generating real cash flow, but also that management is confident that the company is in sufficiently good health to return cash to shareholders. Its also a sign that management values the shareholders, and is willing to reward them with a share of the profits.
While Gammas dividend yield is not high at 1.1%, the payout has risen from 3.95p per share in FY2014 to 7.5p per share last year, and City analysts expect further growth of 10% for this year. The interim dividend was increased by a healthy 12% today, from 2.5p to 2.8p.
Valuation
Analysts forecast FY2017 earnings of 23.7p, which, at the current share price of 669p, places the stock on a forward P/E ratio of 28.3.
While no bargain, that level of P/E suggests to me that investors are willing to pay a premium price for a high-quality company, and I see that as a good thing.
Companies that trade cheaply are often cheap for a reason (think ofTelit Communications) and companies that trade at eye-wateringly high valuations (likeIQE) leave little margin for error. However, a P/E of 20-30 indicates to me that the market is aware that the company offers growth potential, without a level of irrational exuberance attached to the stock.
Lastly, a glance at the chart shows that the stock is clearly in an uptrend. And as they often say in investment circles, the trend is your friend.
Another small-cap stock that has bags of potential
If you’re looking for another under-the-radar small-cap company with significant potential, check out the stock listed in the report A Top Small CapStock.
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