2 small-cap stocks that could deliver unbelievable earnings growth

These two smaller companies may be on the cusp of improved returns.

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Buying smaller companies can be fraught with risk. By their very nature, they lack the size and scale advantages of their larger peers. Therefore, their earnings profiles may be more susceptible to the loss of a major contract or an economic downturn. However, as well as higher risk, they can also offer impressive potential for rewards. With that in mind, here are two companies which could be worth a closer look right now.

Improving performance

Reporting on Monday was provider of hosted managed and cloud computing services, Nasstar (LSE: NASA). Its trading for the full year was in line with expectations, with the company delivering a robust performance within its core division. This helped to offset the previously-disclosed underperformance of VESK-acquired assets.

For example, revenue increased by 36%, with the monthly recurring revenue run rate increasing 54%. The company was able to deliver a gross margin of 69% despite the effects of a weaker pound. This helped to push adjusted profit before tax up 13%, with a final dividend of 0.052p per share representing a 16% increase on the prior year.

Looking ahead, Nasstar is forecast to record a rise in its bottom line of 50% in the current year. Clearly, this is on an adjusted basis, with the company remaining loss-making on a reported basis in 2016. However, with a price-to-earnings growth (PEG) ratio of just 0.3, it seems to offer a wide margin of safety. This could help to protect its investors against any headwinds which may come to light. Therefore, while a relatively risky investment opportunity, it could also prove to be a profitable one.

Solid growth potential

Also offering upside potential in the long run is secure managed hosting and cloud services provider Iomart (LSE: IOM). In the last five years it has delivered a relatively impressive earnings growth profile, with its bottom line rising in four of the five years. Furthermore, its bottom line has grown at an annualised rate of almost 16% during the period, which indicates that its strategy has been sound.

Looking ahead, more growth is on the horizon. Iomart is expected to report a rise in its bottom line of 11% this year, followed by further growth of 8% next year. It trades on a PEG ratio of 1.9, which seems to be a fair price to pay given its consistent track record of profit growth.

For a smaller technology company, Iomart’s dividend appeal remains surprisingly high. It currently yields 1.9% from a dividend which is covered over three times by profit. This suggests that a higher dividend could be warranted in future, while also providing sufficient capital for reinvestment in the business.

With the cloud computing industry offering significant growth in the long term, Iomart seems to be well positioned to deliver high growth over a sustained period. As such, now could be an opportune moment to buy it.

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.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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