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3 growing tech small caps you need on your watch list

My portfolio is dominated by small caps for the simple reason that if chosen wisely they can deliver superior returns compared to large stocks. However, most small companies stay small and so I try to look for ones with scalable, capital light business models operating in favourable industries. Here are three tech businesses that I think share these qualities.

Mitula Group Ltd (ASX: MUA) aggregates online car, job and house ads on its websites and has a presence in 49 countries. It makes money through displaying Google AdSense adverts and also by charging third party sites directly on a cost per click basis.

As my colleague Tom Richardson said in this article, Mitula is well placed to benefit from the growth of the digital economy, particularly in the developing world. Another attractive feature of Mitula’s business is that it can easily expand into new verticals, leveraging its existing user base whilst incurring little additional cost. To this end, the company has recently launched a fashion vertical in Spain.

Aerial mapping company Nearmap Ltd (ASX: NEA) is a very simple business. It sells high resolution aerial photomaps to businesses under a Software as a Service (SaaS) model. Nearmap regularly updates its maps and users are able to view up to date images and monitor changes over time.

Nearmap enjoys a couple of major competitive advantages as a first mover. Firstly, it can spread capture and R&D costs over a large and growing user base, and secondly its vast historical database cannot be replicated.

The company has recently expanded into the giant US market and this venture is still in its investment phase which has temporarily suppressed group profits. Meanwhile, the Australian business is growing strongly and generated $11.7 million in free cash in 2016 after paying for all product and technology investments.

Senetas Corporation Limited (ASX: SEN) makes hardware which robustly and rapidly encrypts data so that it can be safely sent between different locations. The company’s products are certified by four major authorities and are among the most advanced of their type in the world. Certification is important to customers and can take years to achieve so represents a barrier to entry for potential competitors.

Senetas’ products are distributed by European company Gemalto, a global leader in data security. It will be interesting to see if the new “EU-US Privacy Shield” agreement, which requires all EU corporations to protect transmitted data, will boost sales in Europe this year.

I wouldn’t be surprised to see growth in 2017 given revenue rose 150% between 2013 and 2016. Gross margins are over 80% and so most of any incremental revenue will fall to the bottom line.

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Motley Fool contributor Matt Brazier owns shares of Nearmap Ltd. and Senetas. Ltd. 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.