Forget penny stocks. I’d buy these top UK small-cap shares for my ISA instead

Paul Summers — Mon, 16 Nov 2020 07:34:20 +0000

Learning to separate promising small-cap shares from penny stocks is a vital skill for active investors to develop. The former, consistently growing revenue and profits, have the potential to make you rich, in time, especially if they’re held within a tax-efficient Stocks and Shares ISA. The latter, driven by little more than hype, will very likely make you poorer.

With this in mind, here are three examples from the small-cap space that have been doing the business for those already invested.

Trading strongly

EKF Diagnostics (LSE: EKF) specialises in manufacturing point-of-care (POCT) devices and tests. These are used in hospitals, clinics and doctors’ surgeries to provide measure hemoglobin, glucose and lactate levels. As you might expect, increased demand since the emergence of Covid-19 hasn’t done business any harm at all.

In a short-but-encouraging update, the firm stated that “strong trading” last month and a packed order book for the remainder of the year would likely lead it to exceed market expectations on its full-year performance. It’s worth noting that analysts had already adjusted their expectations several times in 2020.

EKF’s share price is up almost 300% since March’s market crash. That said, I think it’s far more likely to hold on to these gains compared to your typical ‘pop and drop’ penny stock. A valuation of 36 times earnings for FY21 is high but unsurprising.

Blooming sales

Everyone knows Harry Potter. Ask who prints the boy wizard’s tales, however, and many people will draw a blank. Just in case you’re one of them, it’s Bloomsbury Publishing (LSE: BMY). Based on recent trading, it’s a name worth remembering.

A beneficiary of the first lockdown and the move to remote learning, Bloomsbury recently reported record earnings for the six months to the end of August.

All told, revenues climbed by 10% to £78.3m. Year-on-year profits grew 60% to £4m, exceeding even management’s expectations. The shares have understandably rallied.

Will this momentum fall once we’re released from lockdown round 2? It’s possible. Then again, true investors rarely concern themselves with short-term fluctuations. It’s the underlying business that matters, and Bloomsbury looks sound. So sound, in fact, management has reinstated its dividend policy.

Shares currently trade at 23 times forecast earnings. That’s not cheap, but a bulletproof balance sheet (£44.1m in net cash at the end of August) helps justify this valuation.

A small-cap treat

Last on my list of top small-cap buys would be global ingredients specialist Treatt (LSE: TET). In its most recent trading update, the £375m-cap reported that FY20 pre-tax profits were likely to be “in line with pre-Covid-19 expectations” of around £14m, despite a slight dip in revenue.

Clearly, the outlook remains foggy due to the coronavirus. According to CEO Daemmon Reeve, however, Treatt is “strongly positioned to benefit from key consumer trends including the preference for natural products, a growing interest in health and wellness, and premiumisation.”

A price-to-earnings ratio of 31 for FY21 is, again, undeniably punchy. Even so, I’d argue that a company with a market-leading position like Treatt is worth paying more for.

Like EKF and Bloomsbury, its finances are in good order. At the end of FY20, the business had £1m in net cash (excluding lease liabilities) in its coffers.

It’s also still paying out dividends. You won’t find many penny stocks doing that!

The post Forget penny stocks. I’d buy these top UK small-cap shares for my ISA instead appeared first on The Twelfth Magpie.

More reading

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Bloomsbury Publishing and Treatt. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

2 under-the-radar stocks on my watch list this September

Rupert Hargreaves — Mon, 11 Sep 2017 09:58:47 +0000

Over the past 12 months, shares in Ekf Diagnostics (LSE: EKF) have chugged higher by 50% as investors have regained trust in the company following a turbulent few years.

Indeed, after hitting a high of 38p per share at the beginning of 2014, shares in Ekf slumped to a low of 8.8p at the beginning of 2016 as losses rose fivefold.

But it now looks as if the firm is back on track. According to its half-year report published today, the medical diagnostics and testing company saw revenues expand 22.8% for the six months to the end of June. Gross profit for the period rose 40.6% to £11.8m. Adjusted earnings before interest, tax, depreciation, and amortisation more than doubled from £2m to £4.6m and the company moved into a net cash position of £4.4m, up from a net debt balance of £4.3m at the end of the same period last year.

Simplify and streamline

These figures reflect management’s efforts to simplify and streamline the business following its previous problems. The number of manufacturing facilities has been reduced from 12 to seven and a rise in orders has helped accelerate profit margin expansion. For the full year, City analysts have pencilled in earnings per share of 0.9p on a pre-tax profit of £3.8m and revenues of £41.6m. Based on these estimates the shares are trading at a forward P/E of 29.4.

Some investors might be discouraged by Ekf’s valuation, but I believe that the shares deserve a place on my watchlist because of the company’s strong growth, rapidly growing cash balance and plans to return cash to investors. Management has recently announced plans to buy back up to 15% of the company’s outstanding shares to reward shareholders and celebrate Ekf’s return to profitability.

Undervalued

Another British diagnostic company I’m keeping an eye on this month is Oxford Instruments (LSE: OXIG). Oxford specialises in nanotechnology tools and services that enable materials characterisation and sample manipulation at the nano scale.

Oxford grew rapidly until 2015 when growth went into reverse and the shares lost around two-thirds of their value in a year. Nonetheless, growth has now returned and investors are starting to trust the company again. For the fiscal year ending 31 March 2018 City analysts are expecting the company to report earnings per share of 53.6p, up 12% year-on-year on a pre-tax profit of £40.5m. Earnings growth of 9% is projected for the following year.

Unfortunately, like Ekf, Oxford also trades at a high valuation, but I believe this is warranted as management’s decision to sell its industrial analysis unit would leave the group more focused on the higher-margin nanotechnology and services, and this specialist focus deserves a premium valuation.

The shares currently trade at a forward P/E of 21. I believe as the market wakes up to Oxford’s more focused business, which should be able to produce higher profit margins, the shares should re-rate to an even higher valuation. For example, shares in specialist engineering group Renishaw trade at a forward P/E of 32.

The post 2 under-the-radar stocks on my watch list this September appeared first on The Twelfth Magpie.