Sage Group, the FTSE 100 technology company is well-known for its accounting software packages, which have powered the firm’s growth. This high margin business has helped the group grow earnings per share by a third in five years. Over the same period shares in the company have risen 127% excluding dividends. But now there’s a new kid on the block and this small-cap’s ambitions should not be underestimated.

Huge potential 

Tax Systems (LSE: TAX) flies under the radar of most investors due to its small size, although the company has large ambitions. 

With a market capitalisation of just under £70 million, it is engaged in supplying corporation tax software to the corporate sector and the accounting profession. The firm was born when the company, formerly known as Eco City Vehicles, acquired software group Tax Computer Systems Limited last July. Since this initial deal, management has also acquired OSMO Data Technology Limited, a provider of automated data extraction software that connects to 295 versions of accounting packages. 

These two deals have built up the group’s offering for customers and Tax’s potential is already starting to shine through.

For the year ending 31 December 2016, the newly formed group produced revenue of £5.8m and EBITDA of £2.7m. City analysts expect the momentum to continue into this year with revenue of £14.8m predicted and a pre-tax profit of £5m pencilled-in, giving earnings per share of 4.2p. Further growth is expected for 2018 with EPS projected to expand by 13% to 4.8p, giving a forecast 2018 P/E of 15.6.

Uncovered growth? 

I believe these predictions could underestimate the group’s growth.

Tax is a highly cash generative business, producing £3.2m of cash from operations during the second half of 2016. During the same period, the company’s capital spending totalled only £400,000 with tax amounting to the same amount and interest on debt coming in at £300,000. Excluding other movements in debt and acquisitions, for the period the group generated free cash flow of £2.1m. This robust free cash flow gives it plenty of financial headroom, which it can use to increase its marketing spend and invest in technology to attract customers.  As revenue expands, free cash flow should expand with it, giving even more room headroom for fiscally beneficial activities such as debt repayment, dividends, and share buybacks. 

This year, City analysts are expecting its larger peer Sage to report a pre-tax profit of £407m on revenues of £1.7bn, if Tax can capture just 5% of this market, the shares could be a steal at current prices. 

The post Investing in this small-cap could help you retire with a million appeared first on The Twelfth Magpie.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has recommended Sage Group. 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.

If death and taxation have an inevitability about them there could be a strong current of demand for services in those areas, so maybe it’s a good idea to look closely at firms specialising in serving those sectors.

A clear strategic direction

Investing in companies when they are new to the stock market can work out well because the growth potential is often high. Management teams can be at their most entrepreneurial and directors keen to make their mark with good effects on growth.

On the other hand, newly listed firms often arrive without much of a trading record, which raises the level of risk. In many cases, investors need to take a leap of faith when they invest in new-to-the-stock-market companies.

I think Tax Systems (LSE: TAX) looks attractive and the firm delivered its full-year results today. The company describes itself as a supplier of corporation tax software and services and was admitted to the FTSE AIM market during July 2016.

Previously, the firm had been an investment company on the lookout for businesses to acquire with opportunities for growth in the technology sector. It was the acquisition of Tax Computer Systems Limited in July that led to the firm’s transition to Tax Systems plc and what looks like a clear strategic direction.

Automating the tax process

Tax Systems aims to deliver end-to-end solutions for tax departments, with as much automation as possible. To achieve this automation, the firm plans on developing in-house software systems and is also on alert for acquisitions such as the post-year-end takeover of OSMO Data Technology Limited, a provider of automated data extraction software.

The directors are optimistic about the firm’s future. Meanwhile, at the current share price around 72p, Tax Systems trades on a forward price-to-earnings (P/E) ratio of just over 15 for 2017 based on expected earnings. 

As a growth proposition, I don’t think the firm looks expensive but, because of the recent acquisition activity, borrowings look quite high at around 4.5 times revenue expected this year, which could become a problem if earnings don’t take off as hoped. Nevertheless, I think Tax Systems is well worth your further research.

Taking care of dispatch

UK-focused funeral services provider Dignity (LSE: DTY) has been a steady grower, pleasing investors for more than a decade and the firm remains attractive today. Demand for the firm’s services is steady, which leads to a stable record of cash generation, as you can see in the table below.

Dignity tends to grow by acquiring smaller funeral service rivals in what has been a fragmented industry. Such ongoing consolidation activity looks set to drive further progress for investors as the firm reinvests its cash flow into growth.

At today’s share price of 2,504p, Dignity trades on a forward P/E ratio around 20 for 2017, which seems fair given the quality of the company’s business and its consistent cash flows.

The post 2 shares with ‘inevitable’ growth potential appeared first on The Twelfth Magpie.

More reading

• The CMC Markets share price is smashing the FTSE 100 in 2026. Is there an opportunity here?
• With a yield of 6.8% and a P/E ratio of 12.1, is this a dirt cheap FTSE 250 stock to consider?
• Will SpaceX, Nvidia, or Alphabet be the first $10trn stock?
• Up 95%! This FTSE 100 stock’s outperformed Nvidia over the past year
• With a 9.3% yield, is this an amazing opportunity to consider buying dirt-cheap Taylor Wimpey shares?

Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.