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One small-cap stock to buy before the market catches on

poker machines

Gaming systems company eBet Limited (ASX: EBT) posted a solid result this morning that suggests the stock is a screaming buy.

The illiquid stock took a few minutes to react, but when it did, it surged 8% to $3.80. This stock is heading to $4.60 in my opinion.

There are no guarantees in life or investments but eBet’s 67% uplift in pre-tax profit to $6.1 million on the back of a 26% increase in revenue to $51.6 million for the year ended June 30, 2015, leaves me reasonably confident about the upside potential of a company that’s really more like a technology player than a gaming systems company.

The company’s result was comfortably ahead of my forecast of $5.5 million in pre-tax profit and $45.6 million in revenue.

This is largely thanks to a better-than-expected performance in its Gaming Systems division, which sells its Metropolis gaming systems technology platform (the backend network that links poker machines) and its innovative stored-value gaming card system CARD-IT.

Around half of eBet’s revenue is recurring from maintenance contracts and will grow as the company’s products gain further traction in the marketplace.

Metropolis was installed in 135 new venues with an additional 55 venues being upgraded to the system during the financial year. This brings the total number of electronic gaming machines on Metropolis to 34,115, which is 23% higher than in 2013-14.

Another pleasant surprise is the 14 cents a share final dividend that comes on top of a 6 cents a share capital return that the company paid earlier in 2014-15. This regular dividend is a big increase over the 5.5 cents it paid last year (eBet only pays regular dividends once a year) and the payout is underpinned by a 48% increase in operating cash flow to $5.3 million.

I was only expecting a final dividend of 6 cents and I suspect we will see the company pay a better than 14 cents dividend in the current financial year, which would imply that the stock is sitting on a decent yield of about 4% (before franking and only 25% of eBet’s dividend is franked).

The only real negative is a faster-than-expected 13% increase in operating expenses, which is behind the drop in the company’s gross margin to 67% in 2014-15 from 70% in the prior year.

But the drivers behind the big rise in cost seem to be one-off in nature as it largely relates to the acquisition of Flexi-Net.

While management has not given guidance for the current financial year, I think it will have little problems achieving a 20% plus increase in pre-tax profit.

Buy the stock while it’s under $4.

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Motley Fool contributor Brendon Lau owns shares of eBet Limited. Follow me on Twitter - https://twitter.com/brenlau

The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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