The Motley Fool

Why I’m avoiding this small-cap tech stock despite 116% gains

Buying shares that have risen sharply in recent months is sometimes a bad idea. Their performance may continue to improve and their bottom lines may continue to grow. However, the market may have priced in a bright future, which leaves relatively little upside for new investors. Here’s an example of a company that despite a share price rise of 116% in the last year may now be one to avoid.

An excellent performance

Leading provider of innovative technology products for the global gaming industry, Quixant (LSE: QXT), has released an update which shows it made strong progress in 2016. All of its product ranges recorded growth. Sales of its core gaming platforms continued to build through the year, which resulted in record sales and demand for gaming monitors.

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Furthermore, customer numbers continued to grow, and included the largest manufacturers for the company’s gaming platforms. This provides a degree of confidence in its long term outlook. And with its performance for 2016 being in line with expectations, investor sentiment should remain buoyant in the short run.

An attractive investment?

Despite its strong performance, Quixant could lack upside potential. Following the more than doubling of its share price in the last year, its shares now trade on a price-to-earnings (P/E) ratio of 20.4. While that’s not particularly high for a small technology company that has just delivered a strong year of growth, its forecasts suggest it may be overvalued. For example, in 2017 Quixant is expected to record a rise in its bottom line of just 9%, which puts it on a price-to-earnings growth (PEG) ratio of 2.3.

This compares unfavourably to many of its larger technology peers. For example, Micro Focus (LSE: MCRO) is expected to record a rise in its earnings of 6% next year, followed by 13% the year after. It has a P/E ratio of 14.5, which equates to a PEG ratio of 1.5 when combined with its growth forecasts. While cheaper than Quixant, Micro Focus also offers greater stability, more consistency and a lower risk investment opportunity. Therefore, its risk/reward ratio is significantly more attractive than that of its smaller industry peer.

Growth potential

Of course, it could be argued that Quixant has a brighter long-term future, and its earnings growth rate could surpass that of Micro Focus. However, the larger company of the two is set to benefit from synergies resulting from the deal to merge with HPE, while its growth strategy remains sound and logical. This should ensure it delivers relatively high earnings growth beyond next year, while also having a strong balance sheet and diversified operations.

While Quixant has been a stunning investment in the last year, its appeal today for investors is somewhat lacking. Therefore, it may be prudent for Foolish investors to instead buy Micro Focus and hold for the long term, as its combination with HPE could prove to be a major success.

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