When it comes to picking the next micro-cap stocks to buy for my portfolio I have a very strict set of criteria. There must be increasing revenues, profits, and dividends. The company must be in a sector which is in growing demand. And I must understand what it does.
On the way to building an $84.6bn fortune, Warren Buffett famously said that “risk comes from not knowing what you’re doing”. I don’t know anything about graphene or fashion, for example. So I don’t invest in companies in those businesses.
But I do understand these sectors.
Micro-cap stocks to buy
My first micro-cap stock to buy is Alumasc (LSE:ALU), an AIM-listed sustainable building products supplier. It’s a specialist in roofing, screening, and plastic-injection moulded products, which sounds incredibly boring. But these are the kinds of businesses that can make a lot of money for their shareholders.
It has a some debt on its balance sheet, so there is some risk there, but it does have nearly £20m in cash, which means it can take advantage of upcoming opportunities. With a forward P/E ratio of 7.8 and a PEG ratio of 0.4, my value investing Spidey senses are tingling! And dividends are returning in force after bosses sensibly cut them to save cash last year.
In half-year results to 31 December 2020, revenue climbed 11% to £45.6m, pretax profits doubled to £5.5m from £2.1m, and earnings per share jumped more than 100% from 5p to 12.2p. That shows me there is growing demand for Alumasc’s low-carbon building products. In the last 12 months Alumasc has brought in £80.4m in revenue. That’s 30% higher than its total market cap. Talk about an undervalued micro-cap stock to buy.
Alumasc does have a number of rivals like Polypipe Group (LSE: PLP) or the much larger FTSE 250 firm Ibstock (LSE:IBST) and competition is fierce at this end of the market. The overall risk here is that Alumasc can’t differentiate itself over time and fails to win new contracts.
Cleaning up
The next stock to buy on my micro-cap wish list is McBride (LSE:MCB). This is Europe’s largest maker of own brand household goods. But at a market cap of just under £150m it’s not particularly well known to investors. Again, like Alumasc, it’s the profitability, stonking value, and growth that’s got me excited here.
There has been “strong profit performance driven by increased demand for cleaning, dishwash and aerosol products,” McBride said in its 2021 half-year report. Pre-tax profits rose 74% to £16.9m. In a post-Covid-19 world I see increased demand for these products in future, too.
There will also be a new policy of annual dividends, McBride boss Chris Smith announced in February 2021. These shareholder payouts should be easily affordable, with McBride’s dividend cover of 5.3. Dividend cover of less than 1 means a business is paying out more in dividends than it makes in profits.
McBride’s net debt of £117.6m is an issue, however. I usually buy business that are debt-free. Smith has set strict debt limits for his team to follow, but if these fail there could be a long-term hit to profits.
The UK’s economic fortunes could rebound faster than predicted, the Bank of England said this week. So the micro-cap stocks to buy, for me, will be the ones able to cash in on soaring household and business spending.
