Small cap growth stocks to watch

David Thornton argues that political uncertainty strengthens the case for investing in small caps.

 Small cap growth stocks to watch

There has been chatter about an economic slowdown but I am not sure much has changed. Valuations among small caps remain reasonable and the case for them is only strengthened when we consider the alternatives.

That talk of a slowdown has seen bond yields fall. Quantitative easing and other factors have conspired to rig this market. We have severe political uncertainty and an inflation rate which spends very little time below 2%. Similarly, the latest GDP growth rate might not have been stunning but it has pick up and is respectable in a European context.

In ‘normal’ times these stats would imply a gilt yield of around 4%, plus a bit for the current political risk. So I simply cannot see why anyone would voluntarily buy gilts. This lack of a viable alternative makes it very hard to switch out of equities.

There are plenty of good quality small caps offering yields of 3% or more. Obviously they will be more volatile than gilts, but from current valuation levels there is a good chance we will have some ‘good volatility’ in the form of capital appreciation. Meanwhile we get a far superior level of income than that from cash or bonds.

AFH Financial Group (AIM: AFHP)

We tipped AFH Financial in February’s Growth Company Investor and the shares have woken up following a strong set of interim results.

Management’s strategy is to build an advice-led (rather than investment-led) wealth management firm, by acquiring IFA businesses and integrating them onto a robust platform. Clients benefit from lower fees and a broader range of services, advisers can focus on their clients with issues like compliance and IT taken care of centrally, and shareholders benefit from the resulting scale economies. Revenue growth of 61% in the half and earnings growth of 49% reflected acquisition activity, though organic net funds under management grew by a creditable 8% which reflects the benefit of this ‘captive’ adviser-led client base.

Margins improved to 21.5% from 19% and management sees 25% as a reasonable medium term target. The prospective p/e of 10.4 looks very good value and outstanding deferred acquisition consideration should be covered by internally generated cash.

RBG Holdings plc (AIM: RBGP)

Litigation specialist Rosenblatt was tipped at 85p last November and the shares have made steady progress.

Maiden results showed revenue ahead 19%. Litigation deal flow is strong and the firm has an excellent reputation in this area. Given the cyclical weakness being seen in corporate, where M&A and capital markets work is being held back by Brexit uncertainty, dispute resolution will be 80% of revenue this year. Management has ensured there is as much flexibility as possible in the cost base and has maintained the utilisation rates of its lawyers despite this background.

The balance sheet had £13m of cash which will help support the company’s litigation funding initiatives. Given Rosenblatt’s expertise it is ideally positioned to source lucrative cases and make quick decisions on whether to acquire them. Litigation funding might take 2-3 years to have a meaningful impact, but it provides longer-term rerating potential for the stock which currently offers a 4% yield.

David Thornton is editor of Growth Company Investor

Other small cap stock analysis by David:

Comments (0)