Can these small cap growth stocks boost your profits?

Do these smaller companies have more room to grow than their bigger competitors?

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I’ve always liked a nice small-cap opportunity, on the grounds that a relatively small company in a large market has more room to grow than the bigger fish in the same pond. But, of course, with small size comes higher risk. Here are two of different sizes that are catching my eye:

Cables in demand

Volex (LSE: VLX) makes cables — data cables, power cables, both standard and customised. On the plus side, there’s massive worldwide demand for such things. But there are also plenty of competitors, many a lot bigger, making the same kind of stuff.

Volex has manufacturing plants around the globe, mostly in Asia, and that suggests it’s pretty well shielded from Brexit effects and from the plunge in the pound. But it really is a very small company, with a market cap of just £33m, and it’s in a low-margin business — which in my eyes makes it risky.

What’s more, the share price has had an erratic ride, and is down 32% in the past 12 months, to 36.4p, and down 86% over five years. So is there any reason to consider buying?

First-half results released today show that, in the words of chief executive Nat Rothschild, “underlying profitability has been maintained,” and that’s despite a “continuing decline in revenues from several of our larger customers.” In fact, although sales fell by 12.3% to $166.1m from the first half last year, underlying operating profit improved by 2.3% to $4.3m and underlying pre-tax profit remained stable at $3.3m (see what I mean by a low-margin business?)

Good news for the longer term is that cash flow was strong and net cash stood at $5.2m (from a $5.4m deficit a year previously).

Forecasts suggest two years of strong EPS growth, which would put the shares on a P/E of 10 by march 2018, with attractive PEG ratios of 0.2 this year and next. On those figures, Volex shares look good value — but don’t forget the small-cap risks.

Construction prospects

Interserve (LSE: IRV) is a significantly bigger company with a market cap of more than £500m, but still a tiddler compare to the FTSE 100 giants. And Interserve’s shares are down a similar 33% over the past 12 months, to 364p.

It’s in a very different business to Volex, offering construction and support services, but that’s also a very competitive market. And Interserve is also another ‘picks and shovels’ company offering business-to-business services. I tend to like those.

Its earnings have grown nicely over the past few years, though we do have a couple of flat years forecast for this year and next. But earnings should be enough to cover predicted dividend yields of around 8% — and the shares are on a lowly P/E of just 5.7 for the current year, dropping to 5.3 next.

I really can’t see a good reason for such a low valuation.

First-half results did show a pre-tax loss of £33.8m, but there was a one-off exceptional charge of £70m that included the impact of exiting the Energy from Waste sector. There’s debt, but it’s coming down, and should stand at around £300m to £320m by year-end.

That will account for some of the low P/E, but with chief executive Adrian Ringrose telling us the full-year outlook is unchanged despite Brexit, and that Interserve enjoys “significantly improved cash flow and healthy future workload,” I see a bargain here.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alan Oscroft has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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