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3 small caps worth watching

As investors regain their confidence in some of Australia’s largest companies, such as the banks or Telstra, the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) is showing strong signs of recovery after its dip between May and June. However, whilst it has been Australia’s largest corporations leading the recovery, there are very few bargains to be found in this area of the economy.

For instance, although the banks could give investors quick returns over the coming weeks (or months), they are very unlikely to outperform the market over the next five to ten years as their growth is largely behind them. Instead, the bargains are down the lower end of the spectrum, where small caps have been largely ignored over the last year due to their low yields or non-defensive nature. Here are three small caps well worth watching.

Jumbo Interactive (ASX: JIN) is an online lottery business that has over the last 12 months proven itself as an up-and-coming figure in the gaming sector. After hitting a high of $3.28 earlier this year, shares have since fallen back to $2.10 (due to the company narrowly missing revenue expectations on its half-year report) which still represents a market smashing return of 833% since late 2011.

The company is the creator of the popular Ozlotteries.com website and has taken its innovative games to a number of new markets including the US. It has also recently received licenses to do business in all German states. As Jumbo continues to penetrate new markets and develop new products, its profitability should improve substantially and should continue to give shareholders outstanding returns. Currently, its market capitalisation is a mere $91 million.

Silver Chef (ASX: SIV) is another promising small cap, valued at $7.95 per share and with a market capitalisation of $230 million. Operating in hospitality, Silver Chef provides equipment funding for small to medium sized businesses in numerous sectors through its ‘Rent.Try.Buy.’ and ‘Rent.Grow.Own.’ solutions. Over the last 12 months, the company has soared 123% and looks set to continue growing as it maintains a happy customer base.

One of the most appealing things about the business (besides its growth prospects) was its recent inclusion in Business Review Weekly’s 50 Best Places to Work list, due to its heavy focus on internal culture. Companies that prioritise employee wellbeing have, in the past, proven to outperform other listed companies in terms of customer satisfaction and have therefore gained in market share.

IMF (Australia) (ASX: IMF) is Australia’s leading litigation funder, providing funding for commercial cases where the claim size is over $5 million. It is a proven player in the industry and has recently expanded into the American market, where it should continue to recognise significant growth. IMF has an outstanding record — 75% of the 142 cases that it has backed have either been won or settled. As its profitability increases, the company will be able to fund bigger cases which could see the company step up to the next level.

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Motley Fool contributor Ryan Newman owns shares in Silver Chef.

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