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3 cheap small cap stocks for your portfolio

Generally speaking, small businesses have the potential to grow much faster than large ones and so a few carefully chosen small caps can transform the performance of your portfolio.

The trouble is the majority of small caps are poor quality businesses and so trying to pick the winners can be dangerous.

The following three companies all pay dividends and have done so for at least five years.

Two of the three are founder led and their management teams have meaningful ownership stakes. Finally, all of them have a strong long-term track record of delivering shareholder returns as listed entities.

1300 Smiles Limited (ASX: ONT) is a Queensland-based dental group. The company’s strategy is to grow both organically through attracting new dentists and opening practices, while acquiring existing chains at reasonable prices.

Since listing in 2005, the stock has risen by 607% and has paid a dividend every year. Refreshingly, founder and Managing Director Daryl Holmes’ salary is just $90,000, despite the fact he has done an excellent job during his tenure. He receives most of his income through the growing dividend stream generated by his substantial shareholding.

The company looks on track to deliver more than $8 million net profit after tax (NPAT) in 2016 and had $7.4 million in cash with no debt at 31 December 2015. Therefore, the stock is currently trading on an enterprise value-to-earnings ratio (EV/E) of under 20 which is reasonable for a growing, defensive and well run business. The icing on the cake is the 3% fully franked dividend.

Vita Group Limited (ASX: VTG) is a mobile phone and IT retailer which sells products and services primarily under the Telstra brand. The company has been very successful in selling mobile phones to consumers and is now targeting the small business market through its growing network of Telstra Business Centres.

CEO and founder, Maxine Horne, and her team have transformed the fortunes of the business over the past five years by opening more Telstra stores, whilst closing underperforming non-Telstra branded sites. Consequently, Vita’s share price has risen by 1,700% since July 2011.

Vita recorded underlying earnings-per-share (EPS) of 11.38 cents for the first half of 2016 and had 7 cents in cash per share after adjusting for debt at 31 December 2015. Estimating full year EPS at 22 cents gives an EV/E of 18.5 and a dividend yield of 3.5% based on a pay-out ratio of 65% at the current share price of $4.14.

This will look like a bargain in a few years’ time if Vita is even half as successful with its Telstra Business Centres as it has been with its Telstra retail stores.

Hansen Technologies Limited (ASX: HSN) is a software developer, specialising in billing systems for utility, telecom and pay TV companies. Its strategy is to acquire overseas businesses that extend its geographical coverage and enhance its intellectual property. As a software company, Hansen benefits from recurring revenues and high profit margins.

Over the past 10 years, Hansen’s share price has risen a staggering 2,708% as it has steadily expanded its global and industry footprints through carefully chosen acquisitions. The company is showing no signs of slowing down and recently announced the purchase of US-based PPL Solutions for just 4x its earnings before interest, tax, depreciation and amortisation (EBITDA).

Based on existing company guidance, I expect Hansen to deliver NPAT of more than $25 million in 2016. It had $23.8 million in cash and minimal debt at 31 December 2015 so is trading on an EV/E of 25 and a 1.6% dividend yield. This isn’t bad for a software business and does not factor in the 7.5% uplift to profits that the PPL Solutions acquisition is expected to deliver next year.

3 Rotten Shares to Sell, and 1 to Buy Today

After a double-digit rally for the ASX since 2016 lows, investors should be on high alert. You’ll find a full rundown below of 3 shares we think you should avoid today plus one top pick worth buying, even if the market turns south and the RBA keeps rates at an “emergency low.” Simply click here to uncover these stocks.

Motley Fool contributor Matt Brazier has no position in any stocks mentioned. The Motley Fool Australia owns shares of Hansen Technologies. 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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