Investing in small-cap stocks can be very profitable if you go for high-quality, well-managed companies. Today I’m looking at two such companies that have strong growth prospects for the year ahead.
The Gym Group
There are no prizes for guessing what The Gym Group (LSE: GYM) does. The £290m market cap group is the owner of 128 budget gyms across the UK and is rapidly rolling out new gyms at a rate of around 15-20 per year. It now has an estimated 22% share of the low-cost gym market and has captured around two-thirds of the market’s growth since March last year. Does the company have investment potential? I believe so.
A trading update released this morning for the year ended 31 December looks solid. For 2017, total year-end memberships rose by 36% to 607,000, with revenue climbing 24%. Management sounded upbeat about the future, with CEO John Treharne stating: “Looking ahead, we have a very strong foundation and a proven rollout model from which to build the business and increase its profitability further.”
Are the shares attractively priced? With analysts forecasting earnings per share of 9.1p for FY2018, The Gym Group currently trades on a forward-looking P/E of 25. While that’s clearly not a bargain valuation, I don’t believe it’s an unreasonable one either, given the company’s growth. If GYM can execute on its growth plans, I see no reason why the shares can’t keep trending upwards.
Another small-cap company with strong growth prospects for 2018 is Restore (LSE: RST). The £640m market cap company provides services such as document storage, document shredding and workplace relocation. The stock is a favourite of UK small-cap specialist Mark Slater,- one of the best stock pickers in the business.
Restore doesn’t have the most exciting business model in the world, yet sometimes, boring investments can be highly successful. In Restore’s case, a £2,000 investment five years ago would now be worth around £10,000, a gain of almost 400%. Are there more gains to come? For long-term investors, I think there could be.
The company stated in September that the second half of 2017 had started well and that the Board expected to deliver a full-year performance “slightly ahead of previous expectations.” Analysts expect the momentum to continue in 2018, with revenue and net profit growth of 6% and 15% forecast respectively. A dividend hike of approximately 24% is also currently anticipated.
What about the valuation? The shares currently trade on a forward-looking P/E of 22.1, which, like The Gym Group’s valuation is not a bargain. However, at the same time, I don’t think that price metric looks excessive either, given Restore’s growth track record and future prospects. A glance at the chart reveals that the share price has been trending upwards slowly for around eight years now. If the company can keep growing its profits, there’s no reason this upwards trend can’t continue.