These quality small-cap stocks look like bargains to me

Paul Summers highlights two small-cap stocks offering both income and growth to investors.

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With many high-yielding stocks in the FTSE 100 looking vulnerable, there’s a lot to be said for investors looking lower down the market spectrum for their dividend fix. Here are two examples I think tick this and many other boxes.

Overreaction?

As a result of its leading status in a niche market, excellent returns on capital, robust balance sheet, and experienced management team, laser-guided equipment manufacturer Somero Enterprises (LSE: SOM) is a company I’ve admired for some time. Following a surprise profit warning earlier this month, as a result of very poor weather in the US, it’s finally taken a place in my own portfolio.

According to the company, trading over the first fives months of 2019 dipped below expectations following record rainfall and the subsequent slower pace of equipment sales to customers (Somero’s technology ensures concrete floors are laid absolutely flat). Despite remaining positive on market conditions, the small-cap revised its revenue and earnings expectations for the year, to $87m and $28m, respectively.  

Unsurprisingly, the market didn’t take this news well and Somero’s shares fell almost 23% on the day of the announcement. 

As you might gather, I consider this an opportunity for new investors to climb on board. While certainly not immune to the economic cycle, Somero continues to invest in its future by expanding its training facility and developing new products.

It’s attempting to grow in other markets such as Europe and China to reduce its dependence on the US and is also a great source of dividends with an expected yield of 5.4% this year. 

There’s a chance that this warning might not be a one-off, of course. On a price-to-earnings ratio (P/E) of 10.5, however, I consider it worth the risk. 

Industry consolidator

Another stock I think looks undervalued is pawnbroker, jewellery retailer, gold buyer/seller and foreign exchange specialist Ramsdens Holdings (LSE: RFX).

Annual results for the 12 months to the end of March were perfectly respectable with the minnow reporting a 17% increase in revenue (to £46.8m) and 4% rise in underlying pre-tax profit (to £6.7m). All parts of the business showed growth with jewellery retail revenue jumping 23% to £9.8m.

A total dividend of 7.2p was declared — 9% more than the previous year and equating to a trailing yield of 3.9%, covered well over twice by profits.

With a market-cap a touch below £60m, Ramsdens still has a lot of room left to grow. And that’s just what it’s doing. 

It acquired 18 stores and five loan books from rival The Money Shop in the previous financial year and another four stores and 12 loan books after March.

Given the latter announced last week that it would cease trading as a result of poor financial performance and a flood of customer complaints, it seems likely that Ramsdens will continue adding to its estate in the not-to-distant future. As CEO Peter Kenyon said a few weeks ago, the company “continues to see further opportunities to grow Ramsdens by capitalising on consolidation opportunities in what remains a highly fragmented market.”

Taking into account all this potential, the diversified business model, solid financials, decent dividend yield, and the recent spike in the price of gold, Ramsden’s continues to look far too cheap on a valuation of just under 10 times forecast earnings. 

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 owns shares in Somero Enterprises, Inc and Ramsdens Holdings. The Motley Fool UK has recommended Somero Enterprises, Inc. 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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