The Motley Fool

3 small cap growth shares that must be on your watch list

Just like every amateur fisherman is out to nab the mythical “big one”, each investor is out there trying to find the next explosive growth stock. No investor has a crystal ball, and the market is littered with plenty more failures than successes.

But here are three small cap contenders that just might light up the market in the coming years. 

  1. Audinate Group Limited (ASX: AD8) 

Digital audio company Audinate develops hardware and software solutions for the professional audio-visual industry. Its flagship product is a technology called Dante, which enables users to easily set up even complex audio networks. Dante cuts down on latency times and simplifies audio networks, with the aim of delivering efficiencies and cutting costs for the consumer. The technology has won a number of international industry awards and is currently being used by a diverse range of clients, from the River Hills Baptist Church in Texas to the Sands Casino in Las Vegas.    

Cash collections for the fourth quarter 2018 were $5.9 million, up from $4.5 million in 3Q18. Its shares have performed well in 2018, up a little over 60% since the start of the year. Audinate currently has a market cap of around $237 million. 

  1. ELMO Software Ltd (ASX: ELO) 

ELMO produces a suite of cloud-based software delivering HR and payroll solutions. As well as its core HR people management software, it offers products that help to automate recruitment, onboarding, professional development and succession planning, as well as a number of customisable eLearning options. 

Like Audinate, ELMO’s share price has surged a little over 60% since the beginning of the year. Total cash receipts for FY18 were $28.2 million, which represents an increase of 55% on the prior year. The company has about $46 million of cash on hand to fund its growth strategy, and claims to have a strong pipeline of sales already lined up for FY19. ELMO has a market cap of $414 million. 

  1. Zenith Energy Ltd (ASX: ZEN) 

With a market cap of only a little over $100 million, Zenith is the smallest company on this list. It is an independent Australian power producer with operations across Australia and South East Asia. Zenith has contracts with US-based gold producer Newmont Mining Services to supply power to its Tanami Gold Mine in a remote area of the Northern Territory, and with Gascoyne Resources Ltd (ASX: GCY) for its Dalgaranga Gold Project in Western Australia.  

In its unaudited preliminary FY18 results released last week, Zenith reported revenues of $51 million, which represented an increase of 64% versus FY17. EBITDA was up 85% to $18 million and NPAT surged an impressive 171% to over $8 million. Surprisingly, the share price fell after the announcement, possibly due to the fact that most of Zenith’s revenues came in the first half of FY18. In fact, of Zenith’s total reported FY18 NPAT of $8 million, $7.39 million came in 1H18. 

This represents a significant slowdown in 2H18. However, with a number of new contracts in its pipeline, Zenith could still be a small cap worth watching over the next couple years. 

Foolish takeaway

Investments in any small cap companies carry significant risks. Before you invest, make sure you do your research. Understand the company and its operations, dig into its financials, and find out what sort of track record its managers and directors have.  

Once you’ve done all your research, look at the company’s share price chart and decide on a price you think you’d be willing to pay. The shares of smaller companies can be quite volatile, so it’s important to decide on a price you think is fair and place an order at this price.  

Finally, only risk an amount of money you’d be willing to lose, and remember to diversify. Your entire portfolio shouldn’t consist of higher risk shares. Balance out your portfolio with some blue chips – less volatile, high dividend-paying shares can provide more consistent income and hedge some of the risk from these smaller cap investments. 

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Motley Fool contributor Rhys Brock has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended AUDINATEGL FPO and ELMOSFTWRE FPO. 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 Scott Phillips.

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