Small-cap stocks can be quite a risky addition to any portfolio. These businesses typically have far less access to external capital, and their size can make it difficult to compete against larger competitors. This is why many companies in this category struggle.
But, every so often, a gem emerges from a sea of mediocrity. And if I can identify them early, then the returns can be explosive. With that in mind, I’ve spotted one small-cap stock that might just fit the bill. Let’s take a look at Somero Enterprises (LSE:SOM).
Automation in the construction industry
Somero is a designer and producer of screed machines operating primarily in the US. These are specialised pieces of equipment that allow construction companies to lay smooth concrete surfaces for structures such as car parks, hospitals and warehouses.
Concrete is far from the most exciting business out there. But it remains a central piece of the global construction industry. What’s more, by using this group’s technology, the final result is significantly higher quality than traditional methods can achieve.
And, more importantly, it requires far less manpower. For example, Kent Companies, a leading concrete contractor in the US, cut its construction team size by nearly half on some projects, while simultaneously reducing completion times.
With e-commerce driving enormous demand for warehousing, and US president Joe Biden committing $2trn to America’s infrastructure, the group looks like it’s ready to enjoy some significant tailwinds. And this may have already started.
Looking at the latest interim results, revenue for the first six months of 2021 came in at $64.4m. That’s around 65% higher versus pre-pandemic levels. And when it comes to operating profits, the performance is even more impressive, jumping from $10m to $23m over the same two-year period.
Combining all this with a near-5% dividend yield, I’m hardly surprised to see the small-cap stock climbing nearly 70% over the last 12 months.
Nothing is risk-free
Business may be booming with further growth on the horizon, but Somero is far from risk-free, especially when it comes to the weather issues. Pouring and laying concrete in the rain compromises its strength and can lead to serious structural problems. Therefore, prolonged periods of bad weather can cause significant disruptions in the revenue stream.
That may seem like an unlikely threat. But in 2019, that’s precisely what happened. The year saw some of the worst storms in America’s history, with extreme cold snaps and heavy rainfall throughout. And with climate change becoming an ever-increasing threat, I think it’s inevitable to see more extreme weather patterns in the future, disrupting the revenue stream once again.
A small-cap stock worth buying?
Also, the firm isn’t short of competition. But its technology appears to be far superior, allowing the group to control a much larger portion of the market share. And with a wide range of machines to meet the varying budgets of its customers, I don’t think this will change anytime soon.
The risk of weather-based revenue disruption is quite concerning. However, management retains a sizable cash position to ensure that all obligations can be met during these disruptive periods. As such, I think the risk is worth the potential reward.
Therefore, I’m keen to increase my existing position in this small-cap stock before the end of the year.
