Stocks with a market capitalisation of less than $200 million, are often overlooked by institutions because they are so small that it is impossible for them to build a meaningful ownership position. Consequently these companies are often mispriced to the benefit of retail investors.
However, before diving in, caution is advised because thousands of companies fall into this category and many of them are cheap for a reason. Personally, I wouldn't touch anything that is not cash flow positive and this basic requirement reduces the number of options significantly.
One such company that has caught my eye recently is Wellcom Group Limited (ASX: WLL). Wellcom creates, manages and delivers designs for corporate clients in a variety of formats including digital, billboards, brochures and 3D animation. Current executive chairman Wayne Sidwell founded the company in Melbourne in 2000 and remains the largest shareholder with a holding of more than 50%. This is important because it means that management and shareholders' interests are aligned.
In its half-year results released on 18 February, revenue was up 24% to $54.8 million and profits were up 11% to $4.6 million. Wellcom paid a higher tax rate in the six months to December 31 2014, compared to the prior year and profit before tax was up 17%, which gives a better indication of how the business is tracking. This is an impressive result but as a long-term value investor I'm only interested if such performance is sustainable and here are six reasons to think it is.
- Wellcom has global reach with offices in Australia, New Zealand, Singapore, Malaysia, the US and the UK. It is able to cross-sell its proprietary Knowledgewell software through this growing international network. The US business was acquired in March 2014 and is the most recent addition to the Wellcom group.
- The company occupies a niche within the advertising industry offering complementary services to the big advertising agencies. It has an impressive client list which includes hundreds of multi-national majors.
- The services Wellcom provides are labour intensive, so staff costs are high and the business does not scale easily. This means the company operates in an area which should not attract too much competition.
- The weak Australian dollar benefits Wellcom when it repatriates profits from overseas entities.
- The company consistently delivers high returns on equity averaging over 16% in the last four years. This shows that management uses shareholder funds wisely.
- Wellcom carries no debt and has cash reserves of $6m leaving it with plenty of room to return capital to shareholders or leverage the balance sheet if the right opportunities present themselves.
Is it a buy?
Of course there are always negatives to consider and for Wellcom the key weakness is its exposure to the cyclical retail industry. However, the stock comes with a 5.4% fully franked dividend yield and is good value given it has a forward price to earnings multiple of less than 15.
