Investing in small caps has delivered big results for many investors over the last year. Fast-growing smaller firms have lived up to their reputation for outperforming big-cap stocks, but will this situation continue as valuations rise?
Shareholders of infection control specialist Tristel (LSE: TSTL) have seen the value of their shares rise by almost 40% to 159p over the last 12 months. But today’s full-year results from Tristel appear to have left the market unimpressed, despite a 12% rise in revenue. In this article I’ll explain why this might be.
I’ll also contrast Tristel with a larger manufacturer of healthcare products, joint replacement specialist Smith & Nephew (LSE: SN).
Sales of Tristel’s infection control products rose by an impressive 12% to £17.1m during the year ending 30 June. Adjusted pre-tax profit rose by 27% to £3.3m, while adjusted earnings rose by 20% to 6.62p per share.
The group’s total dividend — including a 3p per share special payout — rose by 11% to 6.33p per share. Tristel ended the year with net cash of £5.7m, up from £4m at the end of last year.
However, in my view these impressive adjusted figures are clouded by the exclusion of the expenses relating to a £1m stock option bonanza enjoyed by management earlier this year.
This share-based payout is one of the main reasons why Tristel’s weighted average share count rose from 40.7m to 41.9m last year. The dilutive effect of these new shares pushed Tristel’s reported earnings down by 8% to 5.01p per share. This equates to a trailing P/E of 32.
Is Tristel too expensive?
Tristel looks expensive based on historic earnings. However, broker forecasts suggest that adjusted earnings will rise by 15% to 6.8p per share this year, putting the stock on a forecast P/E of 23.
Stock option costs should fall this year, so adjusted earnings will hopefully be closer to the group’s reported numbers. A planned move into the US market in 2018 could give Tristel access to new markets worth up to £18m, according to management estimates.
Although Tristel shares aren’t obviously cheap, I believe they could still deliver further gains. I’d hold for now.
A hip replacement stock?
Shares in joint replacement group Smith & Nephew have risen by 113% during the last five years. But the group’s growth appears to have slowed. Smith & Nephew shares are flat so far this year and don’t look especially cheap, on a 2016 forecast P/E of 18.1. The forecast dividend yield is just 2%, which isn’t very tempting either.
Things could be about to improve, however. Earnings per share are expected to rise by 12% next year, bringing the forecast P/E down to 16. There’s also the potential for a takeover bid. The combination of the weaker pound and Smith & Nephew’s stagnant share price means that for a US buyer, this company would be cheaper than it was at the start of 2016.
It’s worth remembering that despite a £10bn market cap, Smith & Nephew is only a medium-sized player in this sector. A bid could make sense.
Overall, I’d argue that as with Tristel, Smith & Nephew looks fully priced at the moment but has decent medium-term potential.
Could this stock rise by 200%?
Smith & Nephew's 113% gain over the last five years has been dwarfed by the 315% profit enjoyed by Tristel shareholders over the same period.
The Motley Fool's experts have been scouring the market for new growth bargains and believe that they've identified a potential buy.
The company featured in 1 Top Small-Cap Stock From The Motley Fool is a high-quality UK firm with a track record of growth and improving profitability.
This exclusive report is free and carries no obligation. To receive your copy today, simply click here now.
Roland Head 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.