Time to sell these high-flying small-cap growth stocks?

Paul Summers takes a closer look at two market minnows you might wish you’d bought last year.

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Back in June last year, I suggested that shares in small-cap technology group Avon Rubber (LSE: AVON) were beginning to look rather cheap for such a quality company.

Since then, the value of the business — which operates in two very disparate markets (respiratory protection systems and milking point solutions) — has increased a very satisfying 36%.

Should those who benefited from the rise now consider jettisoning the stock from their portfolio? Not if today’s pre-close trading update is anything to go by.

Fair value?

According to management, trading in the second part of the financial year has “continued to be strong“, with expectation around profits for the full year likely to be met. 

Over at the company’s Protection division, revenue growth for the 12-month period is expected to be roughly 7% at constant currency, supported by recent orders from the US Department of Defence. A total of 182,000 masks are expected to be shipped to this client in the current financial year. 

Elsewhere, the company continues to sell its products to those working in law enforcement with growth being recorded “across the portfolio in all geographies”. It would seem, however, that this performance hasn’t been replicated in the “tougher” Fire market.

In dairy, Avon has seen improved trading in North America (a key market) over the second half of the year. Revenue growth in 2017/18 is now expected to be around 4% at constant currency.  

A rise of almost 2% in early trading suggests the market is satisfied with these numbers. That said, I’m not sure I’d add at the current time if I already owned a slice of Avon. At 19 times earnings for the next financial year, I don’t think it’s unreasonable to suggest that the Melksham-based company is approaching fair value, although some may not agree given its ongoing growth. 

But I would not sell. With management talk of a “strong order book” and the firm being “well positioned” to continue growing in 2018/19, a (more) gentle ascent could still be on the cards. To me, Avon Rubber looks a solid hold right now.

Another strong riser

Of course, Avon isn’t the only small-cap that’s performed for investors in recent months. In January, I profiled bio-decontamination equipment supplier Bioquell (LSE: BQE), suggesting that the positive momentum witnessed in 2017 would likely continue.

Priced at 342p back then, the shares now change hands for 550p. That 60% gain in under eight months neatly summarises why small-cap growth stocks remain such a draw for private investors prepared to endure increased volatility for the prospect of swifter capital gains. 

July’s interim results gave a snapshot of why this minnow is now appearing on more investors’ radars. Despite currency headwinds, total revenues rose by 13% at constant currency to £15.7m over the six months to the end of June while pre-tax profit roared ahead by 41% to £2m.

Having disposed of non-core assets, Bioquell has now positioned itself for “more predictable revenues and higher quality earnings”, according to Executive Chairman Ian Johnson. Indeed, it now expects to exceed analyst predictions on full-year profit.

The only downside to all this is that the shares look even more expensive than before. At 45 times forecast earnings before today, investors will need to be very confident that Bioquell will keep its word. 

While I wouldn’t necessarily dispose of the stock just yet, it does pay to remember that high expectations frequently result in eventual disappointment. 

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.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Avon Rubber. 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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