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3 tailwind stocks for powerful returns

Tailwind investing… What is it and how can you make it work for you? Well the first question is easy, tailwind investing is investing in businesses that are likely to face a long-term improvement in business conditions. I’ll get to the second question, but first, I want to introduce Warren Buffett’s Noah principle (from his 1980 Letter to Shareholders):

Noah Principle: Predicting rain doesn’t count, building arks does.

It was all very well to accurately predict the explosion in internet and mobile data use, but that alone was not enough. Those investors who bought shares in Telstra Corporation Ltd (ASX: TLS) in 2011, around the time it was clear Telstra would be a beneficiary of these trends, are sitting on gains of over 100% in less than three years including dividends – and that’s a blue-chip stock! Smaller companies can generate much higher returns as they grow…

So with that in mind, here are three small companies that tailwind investors are watching:

1) SDI Limited (ASX: SDI) is a company that makes and distributes amalgam and composite restorative materials for dentists and is already up over 20% since certain value investors identified the opportunity recently. Although I did buy shares myself, I’m not as enthusiastic as some others because the company’s products – while competitively priced – are no longer favoured by dentists in Australia.

Having said that the company recently announced its second-half results would be much improved on the prior corresponding period and the price remains reasonably attractive at just under 60c (though my purchase price is lower). Directors have been buying significant chunks of shares at less than 10% below current prices, indicating that shares are unlikely to be particularly overvalued.

Potential tailwinds: The company exports 90% of products. Worldwide, I posit that humans are living longer and becoming more aware of dental health, especially in places like Brazil and China where poverty is, gradually, being alleviated. SDI should benefit from this trend. Also, as the mining capex boom subsides, the Australian dollar should weaken, boosting SDI’s profits in AUD terms.

2) CPT Global Limited (ASX: CGO) is a small IT company that specialises in performance tuning. That means it improves on the systems set up by other IT crews with goals such as improving speeds, reducing required computing resources or adding a greater number of users more easily. While I’m generally not a fan of the lumpy and often unpredictable nature of IT consulting revenues, I’m very attracted to the current price of CPT Global. The stock is quite illiquid, so savvy buyers will exhibit patience – there have been sellers at 70c for quite some time. Though the upcoming dividend is not known, it’s quite possible the company will pay a generous dividend yield of over 8% (annualised).

Potential Tailwind: IT systems continue to become more complex as software and hardware improves. As a result, so does the potential benefit of getting the “second opinion” that CPT Global can provide.

3) Somnomed Limited (ASX: SOM) is a company that makes and sells mouthguard-like devices for continuous open airway therapy for sleep apnoea. While Somnomed faces formidable competition from ResMed Inc. (CHESS) (ASX: RMD) and Fisher & Paykel Healthcare Corp Ltd (ASX: FPH), there is a point of differentiation because Somnomed’s product is far more portable (and quieter, as it is not a machine).

Potential Tailwinds: Not only are people becoming more mobile (making portability important), but sleep apnoea is more common in older, overweight people. The ageing population will therefore increase the number of sleep apnoea patients as will the ongoing obesity epidemic.

Please note: Although I like each of these 3 stocks, they are all micro-caps and therefore too risky for many investors. Those looking for a good balance between growth prospects and risks should look for a growing company that has already proven itself..

After all, SDI limited is NOT the only tailwind stock that has seen director buying at around the current share price.

This little gem of a company has grown earnings per share for five years in a row, pays a strong dividend and better yet, 2 directors recently bought shares on market- at very very close to current prices. Personally, I'm surprised it's still this cheap, and I doubt the opportunity will persist after the annual results are released.

The Motley Fool has issued a firm "BUY" rating on this small but ultra promising ASX company... and you can get the name and code FREE right now. Click here for your free copy of "The Motley Fool's Top Stock for 2014."

Motley Fool contributor Claude Walker (@claudedwalker) owns shares in Somnomed, SDI Limited, and CPT Global. Disclosure is important, so good on you for reading this far.

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