I’m a firm believer in investing in small caps. Whilst there is a higher proportion of poor investments at the bottom end of the market, the good ones have the potential to deliver extraordinary returns.
In my opinion the following seven stocks fit into the second category.
Dental chain 1300 Smiles Limited (ASX: ONT) has an excellent track record. It has grown earnings-per-share (EPS) from 9 cents in 2007 to 32.2 cents in 2016. Meanwhile, dividends have increased from 6.8 cents per share to 22.5 cents last year. Despite its strong growth profile, the company has maintained a healthy balance sheet and currently holds $7.5 million in cash and no debt.
The stock has a price-to-earnings ratio (PER) of 23.8 which is reasonable for such a well-run business.
Data#3 Limited (ASX: DTL) is another company with an exemplary management team. As a provider of IT products and services, Data#3 is vulnerable to the business investment cycle but over the long-term it has produced excellent results for shareholders. Dividends per share have risen from 3.6 cents in 2007 to 8 cents last year.
At current prices the stock pays a 5.3% fully franked dividend yield and despite cyclical peaks and troughs I would expect dividends to continue rising over future years.
Financial software company GBST Holdings Limited (ASX: GBT) recorded weak results in 2016 as it transitioned to a new leadership team but has been another strong long-term performer. New CEO Robert DeDominicis has emphasised the need for the company to invest more heavily in R&D which may hold back profits in the short-term but could lead to higher returns later.
The stock trades on a PER of 19 based on adjusted EPS for 2016
Online advertising company Mitula Group Ltd (ASX: MUA) listed in 2015 and operates 79 sites across 49 countries. It is a capital light business with high operating leverage so profits grow faster than revenue and it generates lots of free cash. Many of Mitula’s sites are in developing countries which I expect to drive revenue growth over coming years.
Based on my profit estimate for 2016, Mitula currently trades on a PER of 17.
United Overseas Australia Limited (ASX: UOS) has a multi-decade track record of generating superior shareholder returns under the current management team. Unlike many property developers the Malaysia-based company also holds a substantial net cash balance. Despite these qualities, United Overseas trades at a 30% discount to its net tangible assets.
Dental restoratives manufacturer SDI Limited (ASX: SDI) is a family run firm with a long and successful history. Profit growth has returned in recent years following a period of high silver prices and unfavourable exchange rates. The business is becoming decreasingly dependent on silver as it transitions to sales of higher margin composite and ionomer based products and so future shocks are less likely.
Despite its defensive qualities and world class R&D capabilities, SDI trades on a PER of 15.2.
Integrated Research Limited (ASX: IRI) makes software that monitors the performance of companies’ IT systems. EPS has risen from 3.3 cents in 2007 to 9.3 cents in 2016 and the company enjoys customer retention rates of over 95%.
With a PER of 24.2, Integrated Research looks good value for the long-term investor.
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Motley Fool contributor Matt Brazier owns shares of Mitula Group, SDI Limited, and United Overseas Australia 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.