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Forget the FTSE 100! Why I think this bargain small-cap with a 6% yield could help you retire early

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I hold my hands up. Back in February I called it wrong on travel website Hostelworld Group (LSE: HSW). The hostel booking firm’s premium rating proved unsustainable in the face of slower earnings growth and tough competition. Its share price has fallen by nearly 50% since then.

One reason for this slump was a change of accounting policy. The decision to offer free cancellations means the company can’t recognise some sales until a booking is completed. This change meant that half-year pre-tax profit fell by 26% to €7.6m.

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I’m now tempted to buy

What’s interesting about this situation is that the underlying business still seems to be performing well.

Management said that without the change to revenue recognition policy, adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) would have risen by 9% to €14.1m during the first half of this year.

I suspect that one reason why the shares have fallen so heavily is that since April, fund manager Neil Woodford has reduced his funds’ stake in Hostelworld from 25.4% to just 9.45%.

My sums indicate that Mr Woodford has fed more than 15m shares into the market. For a small-cap like this, such heavy selling is almost certain to have depressed the share price.

I don’t know if Mr Woodford plans to keep selling. But I do know that Hostelworld chairman Michael Crawley recently spent £155,000 on the firm’s shares.

Too cheap?

Looking at the firm’s accounts, I can see at least one reason why Mr Crawley might have decided to buy more shares.

Over the last 12 months, Hostelworld has generated free cash flow of £21.6m. That gives the shares a price/free cash flow ratio of just 8.6. That’s pretty cheap.

Broker forecasts put the stock on a 2018 forecast P/E of 13.4, with a dividend yield of 6.2%. Earnings are expected to rise by 23% in 2019, giving a forecast P/E of just 10.9.

That looks good value to me for a growth business. I rate Hostelworld as a buy.

Is this company paying too much?

Audio-visual equipment manufacturer Vitec Group (LSE: VTC) is another small-cap tech stock I rate highly.

The firm’s past acquisitions seem to have been reasonably priced and successful, as I explained in August. But a deal announced today has left me scratching my head.

Vitec will pay up to $59.9m to acquire Amimon, a company that makes chipsets for real-time wireless video transmission. These products are mainly used in professional filmmaking.

The technology is a logical fit and Amimon components are already used in some of Vitec’s own products. Taking Amimon in-house should allow Vitec to develop a stronger competitive advantage, in my opinion.

My concern is that it is paying almost $60m for a company that generated an operating loss of $0.7m on sales of just $18.6m last year.

Big savings could boost profits

Management expects to make big cost savings by integrating Amimon. In a statement today, the firm said that its Creative Solutions division should generate an extra $20.5m of EBITDA over the next three years, as a result of the deal.

If that’s possible, then this could be a smart, far-sighted move. But I can’t help wondering if Vitec is paying up to prevent another bidder making a move on Amimon.

I admit this is only guesswork on my part, but for now I think the firm looks fully priced.

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Roland Head has no position in any of the 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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