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This super small-cap could beat Purplebricks Group plc

Purple Bricks. Fair use.

Today I’m going to look at a small-cap stock with a market cap of £27m. This puts it below the radar for most fund managers, but makes it potentially attractive for active small-cap investors.

The company in question is Sopheon (LSE: SPE), which provides software to help companies manage innovation and product development. The firm’s client list includes blue-chip names such as PepsiCo, Proctor & Gamble and pharmaceutical giant Merck. So it seems to be a fairly credible business.

Sopheon’s revenue rose by 11% to $23.2m in 2016, while pre-tax profit rose by 125% to $2.7m. This dramatic increase was mostly down to a reduction in research, development and administrative costs, which fell from $7.1m in 2015 to $6.4m in 2016.

The company issued an upbeat AGM statement today. So far this year, 20 licence orders have been received, up from 14 at the same point last year. Revenue visibility for the full year is currently $17.5m, up from “just under $17m” last year. These figures suggest to me that the strong momentum seen last year is continuing, although revenue per licence may still be falling — a trend the company reported in 2016.

Sopheon ended last year with net cash of $4.2m, so debt doesn’t seem to be a problem. However, one risk facing shareholders is the prospect of serious dilution if £2m of convertible loans (due in 2019) are turned into shares. Doing so would increase the share count by 2.6m, or about 35%, effectively reducing earnings per share by about 26%.

For this reason, I’d argue that with a forecast P/E of 15 for 2017, Sopheon is fairly valued at present. I’d hold at current levels.

Will this disrupter make it big?

Shares of online estate agent Purplebricks Group (LSE: PURP) are worth 255% more than they were one year ago. Annual sales have risen from £3.39m in 2015 to a forecast level of £43m for the year ended 30 April 2017.

Encouragingly, the group’s UK business is expected to report a full-year adjusted EBITDA profit this year. The firm’s strong growth is expected to continue, but it’s worth noting that Purplebricks shares now trade on a price-to-sales ratio of 40. That’s astonishingly high, especially for a lossmaking business.

Investors are clearly pricing-in a dramatic increase in sales and profits in the future. One of the main reasons for this is the recently announced plan to expand into the US market. If successful, this could open the door to a market many times bigger than the UK.

However, gaining market share in the US — in the face of growing competition — is unlikely to be easy. Even if Purplebricks is eventually successful, I wouldn’t be surprised to see the group’s share price take a sharp step backwards at some point.

In my view, the valuation could take a sharp knock if market sentiment changes or if overseas growth is slower than expected.

For what it’s worth, I think it’s a good business that could be worth more at some point in the future. But I suspect shareholders will have a rocky ride. I believe a very long-term view will be needed to have any chance of making a profit from current levels.

This could be today's top small-cap buy

Sopheon and Purplebricks may deliver further gains for investors. But our top analysts believe they've identified a small-cap stock which deserves their 'Best Buy' rating.

They believe that the company in question could be undervalued by as much as 43%. The business concerned is a profitable UK operation with a solid history of growth.

If you'd like details of our analysts' findings, then download 1 Top Small-Cap Stock From The Motley Fool today. This exclusive report is free and carries no obligation. To get your copy, click here now.

Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended PepsiCo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.