Should you buy these 2 small caps backed by Neil Woodford?

While it’s well known that fund manager Neil Woodford is heavily invested in key FTSE100 healthcare and tobacco companies, it’s a lesser known fact that Woodford’s Equity Income fund actually holds a high proportion of small-cap stocks. Here’s a look at two small companies that Woodford owns.

Equiniti Group

With a market cap of just £600m, Equiniti Group (LSE: EQN) appears to be a relatively small company, yet a closer look reveals that it’s actually one of the UK’s largest outsourcing firms, with 3,500 employees across 28 locations and revenue of £369m last year.

Equiniti provides technology to a broad range of financial services companies and is the UK’s leading provider of share registration and associated investor services. The company also has market leading positions in administration of employee share plans, pensions administration and software, and employee benefit schemes.

It’s been a volatile year for Equiniti shares, with the company listing on the London Stock Exchange just under a year ago, and suffering an 8.5% fall on its first day of trading as well as heavy falls in February and June. Yet the volatility hasn’t put Neil Woodford off, with the fund manager recently participating in a placing of the company’s shares that allowed him to almost double his position in it. Woodford obviously sees something he likes in Equiniti.

City analysts forecast revenue of £391m for FY2016, an increase of 6% on last year, and adjusted earnings per share (EPS) of 15p. That puts Equiniti on an undemanding forward looking P/E ratio of 13.3 times earnings, which combined with a forecast dividend yield of 2.5%, looks quite attractive in my opinion.  

With only 40% of existing customers taking a full complement of products, there’s opportunity for the firm to grow through more deeply penetrating existing clients. Management believes the group can deliver mid-single-digit organic revenue growth within the 3%-7% range per annum with higher EPS growth driven by margin improvement and use of cash.

With good earnings visibility from contracted and recurring revenue streams and high levels of free cash flow, Equiniti certainly looks to have a lot of potential.

Stobart Group

The next Woodford small-cap is Stobart Group (LSE: STOB), which owns and manages a range of key infrastructure sites and operates business divisions delivering critical support services to the energy, aviation and rail sectors.

Woodford is clearly a fan of Stobart Group, buying a 4% stake in the company almost immediately after he left Invesco Perpetual in 2014, and recently taking his holding to over 15% of the issued share capital.

The £580m market cap stock has enjoyed strong share price momentum this year, rising almost 60%, and with revenue forecast to grow from £127m in FY2016 to £185m in FY2018, there’s a chance this momentum could continue. Chief  executive Andrew Tinkler recently said he planned to return £300m to shareholders from the sale of 12 assets, and the prospect of increased dividends has clearly boosted investor confidence.  

With city analysts pencilling-in earnings of 5p for FY2017, Stobart doesn’t look that cheap on a forward looking P/E ratio of 33.2, yet if management can deliver on the dividend, shareholders should be rewarded with a healthy dividend payout.

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Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.