2 small-cap stocks headed for profitable recovery

These 2 small cap shares have plunged, but they could be set for strong recoveries.

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It’s not nice when a company’s share price takes a dive. But when it happens, it can often throw up a nice recovery candidate. Here are two that I reckon have tempting potential.

Technology services

Servelec (LSE: SERV) provides software, hardware and related services across a wide range of industrial sectors, including healthcare, education, oil and gas, utilities, broadcast, and rail.

Things were going swimmingly until 15 June last year, when the company issued a profit warning and told us it was going to fall short of its 2016 expectations. The shares slumped by 32% to 237p on the day, although they have since recovered, and currently stand at 280p, on the day the preliminary results were released.

The results were in line with revised expectations, and showed a 29% fall in pre-tax profit from continuing operations, leading to an 11% fall in adjusted EPS. But the full-year dividend was lifted by 10% to 5.65p per share, and signs of recovery were starting to show. Highlights include a strengthening order book, the company’s automation business recovering “on the back of significant project wins“, and several acquisitions being made.

Chairman Richard Last said that the “situation around procurement delays, noted in our trading update in June 2016, has improved and we are optimistic that Servelec will return to growth in 2017“, and the City’s analysts appear supportive with a 20% rise in EPS penciled in for this year followed by a further 9% in 2018.

The dividend is expected to keep on rising ahead of inflation, and though it’s set to yield only a little over 2%, it should be very well covered by forecast earnings.

It’s often suggested that profit warnings come in threes, but I don’t see that here and I think Servelec is on the happy road to recovery.

Treble whammy

The first warning from St Ives (LSE: SIV) came in April 2016, telling us that “the outlook for the final quarter, and for the following financial year, has deteriorated“. Then the printing and marketing services firm added in January that its pursuit of new business was “taking longer than previously anticipated” and that we will not see “full benefit of the new work we have won until the final quarter of the current financial year“.

If that wasn’t enough, in February we heard that a contract with HarperCollins will not be renewed when it ends in June. That’s three bits of bad news, and three hits to the shares, which are now trading at 52.5p — but at least the firm’s first-half results haven’t done any further damage.

In fact, I think the worst is probably over and I see St Ives’ recovery efforts as starting to bear fruit. The firm stressed the importance of its Strategic Marketing business, with chief executive Matt Armitage speaking of “a number of exciting new projects being won from existing and new clients” and telling us he is confident of its long-term growth.

Mr Armitage added that the firm is considering options for its Marketing Activation and its Books segments, so we could see something drastic there in the coming months and that might cause a little more share price volatility.

But with forecasts putting the shares on a forward P/E of only 3.9 for this year and 4.3 next, I see more pessimism built into the share price than is deserved. I see a risky but potentially profitable recovery investment.

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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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