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5 growing small-caps that could be big winners

There’s a fine line between speculative and early-stage investments. Personally, I draw the line at whether a company is cashflow positive and likely to stay that way, although it is also important to make sure that management are focused on returning that cashflow to shareholders.

One speculative company that has good form in that regard is eServGlobal Limited (ASX: ESV), which provides mobile payment and finance solutions. While the company has not had positive operating cashflow since 2008, it does have a history of returning cash to shareholders when it can. For example, when it sold a business in 2011, it paid out a whopping 29c to shareholders. The company is advancing its newer HomeSend product by forming a joint venture with Mastercard and telecommunications company BICS. This will result in an one-off accounting profit of over $33 million in the current financial year, but the real cashflows might still be a while away.

One of the most impressive growing microcaps on the ASX is mobile payments and digital advertising company Mobile Embrace Limited (ASX: MBE). The company has seen its shares rocket over 970% in the past year as it transitions from speculative micro-cap to growing small-cap. Some people I know have made a ten-bagger out of Mobile Embrace. At just over 20c per share, Mobile Embrace trades at around 20 times my (very) approximate estimate of FY 2014 free cashflow. Should it drop about 25%, I would be sorely tempted to buy, because although it operates in a rapidly changing and hard to predict industry, it has a strong tailwind since mobile advertising (and commerce) is becoming more important.

Redflow Limited (ASX: RFX) is exciting conscious capitalists with its battery technology that is increasingly useful in the renewable energy era for obvious reasons. Because the electricity grid is so expensive it will, in my opinion, be slowly supplemented with solar and battery storage. I would also imagine Redflow’s batteries have value as a backup power source for data-centres and in remote locations (with solar). However, it’s essential to realise that the company is not cashflow positive and is currently raising cash at 11c per share – it last traded at 16c.

One growing small cap that is no longer speculative is RXP Services Ltd  (ASX: RXP), which provides technology consulting services. The company is a collection of smaller businesses, and is making acquisitions quite rapidly. This makes it very difficult to discern organic growth and the underlying performance of the businesses. Nonetheless, directors have made share purchases on market at above current prices, and I was heartened to see that the company provided a conference presentation to the ASX the day before it was made in April. While it does look a tad too expensive at 68c, shares recently dropped under 60c, which is a tempting price for me. The company says that, “the momentum we built up in the first half combined with a number of new client wins will see strong second-half FY 2014 results.”

This contrasts with the speculative pearl producer Atlas Pearls and Perfumes Ltd  (ASX: ATP), which provided to the ASX a presentation that was apparently out of date, quoting the share price before it rose over 40% in less than a week. An investor relations firm representing Atlas Pearls focussed my attention on the company by pointing out that it is well positioned to profit from an increase in pearl prices. However, I’d need a hefty discount to net tangible assets to be buying Atlas Pearls shares – I feel far more comfortable with the attitude demonstrated by RXP Services.

Please Note: The best way for management to show that shares are undervalued is to buy them on-market with their very own cash.

Indeed, the share price of this growing company is still only about 5% above the price 2 directors paid quite recently. Better yet, the CEO owns over 15%! However, the share price is up over 5% in two weeks so discover this stock now, before it's too late.

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Motley Fool contributor Claude Walker (@claudedwalker) does not own shares in any of  the companies mentioned in this article.

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