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Have you got these 2 small stocks on your watchlist?

The beauty of small companies is twofold. Firstly, many brokers and fund managers are unable or unwilling to research them which means there is more potential for mispricing of small stocks; secondly, small firms have the potential to grow into big firms which can mean enormous capital gains for investors lucky enough to find them early and stick around for the growth.

Here are two stocks which caught my eye last week.

Sterihealth Limited (ASX: STP) is a niche provider of collection and disposal services to the healthcare sector. The company’s services include medical waste disposal management. Sterihealth, which has a market capitalisation of $24.5 million, just released a reasonable set of half-yearly results. The highlight was a 9% increase in revenue however the negatives were a small decline in net profit after tax to $1.94 million, a highly leveraged balance sheet and no interim dividend.

Pricing: Trading on a price-to-earnings (PE) ratio of just 6.3 times annualised half-yearly earnings and with near double digit revenue growth this niche provider could be worth keeping an eye on.

eBet Limited (ASX: EBT) is a systems developer and solutions provider to the electronic gaming machines market. While most investors’ attention is on the two big players in this space, namely Aristocrat Leisure Limited (ASX: ALL) and Ainsworth Game Technology Limited (ASX: AGI), eBet with its market capitalisation of $44 million appears to be missing the attention of investors. While revenue was flat during the first half, normalised net profit after tax rocketed 25% higher.

Pricing: If one annualises the 5.9 cents per share in first-half normalised earnings then eBet is trading on a PE of 24.5. This doesn’t sound cheap, however if the company can grow its revenues, the leverage within the business could see earnings continue to grow at a solid clip.

Foolish takeaway

The S&P/ASX 200 Index (Index: ^AXJO) (ASX: XJO) is now approaching levels last seen before the market plunged in mid-2008. Naturally with the market having climbed higher, finding value is getting tougher. Reporting season can create opportunities for investors as new information comes to light on a company, this can be particularly beneficial in the small and mid-cap sectors where there can be a greater time lag between new information becoming available and the market waking up to the fact.

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Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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