2 small cap tech stocks to consider and one to avoid

Over the past 12 months, two small cap Australian software companies have posted gains of 550% and 476%, but there could well be more gains ahead.

Prophecy International Holdings Limited (ASX: PRO) and Adacel Technologies Limited (ASX: ADA) are the two in question, with market caps of $129 million and $93 million respectively.

Let’s take a closer look at Prophecy to start.

Prophecy designs, develops and markets a number of software products with the main two being SNARE and eMite. SNARE provides network administrators with tools to define, monitor, track, gather and report all relevant IT network security events. The system is relied upon by many thousands of organisations, including government agencies, and in this day and age, when hacking is a very real threat – you can see demand for SNARE rising. eMite provides business intelligence analytics to a multitude of enterprise customers including Allianz, HP, UBS, ANZ, Toyota Financial Services, NSW office of State Revenue not to mention many others. Revenues are growing strongly – with SNARE sales up 127% last financial year.

Adacel Technologies is also growing fast, thanks to demand for its Air Traffic control and simulation systems, as well as its voice recognition software. The company appears to be on a growth spurt, recently signing a number of long-term contracts, and revenues jumped 27% last financial year. Adacel recently upgraded its 2016 financial year profit before tax forecast to be 50% higher than the previous year.

While both companies aren’t cheap on trailing metrics and following strong gains as mentioned above, they both show no signs of growth slowing just yet and the 2016 financial year could be another great year.

The company to avoid is IT contractor PS&C Ltd (ASX: PSZ). PS&C listed in November 2013 at $1.00 and its shares are currently trading at 99.5 cents – for reasons you’ll soon see. Despite operating in the high growth cyber security market, PS&C has twice disappointed the market – once by missing its prospectus forecast, and then again in June 2015. Increasing earnings have come mainly from new acquisitions and the company appears likely to make more acquisitions, as the company says, ‘additional debt facilities put in place to assist with funding growth’. PS&C may sport a cheap price with a P/E ratio of 7.7x, but it appears there’s a valid reason for this.

Noted small cap fund manager Pie Funds recently sold out, saying, “PS&C Limited is one we got wrong”, and labelling the company, ‘not a bad business, just low quality’.

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Motley Fool contributor Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia owns shares of Prophecy International Holdings Ltd.. 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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