After sales rocket 380%, is this small cap a better buy than BAE Systems plc?

Filtronic (LSE: FTC) has had a long and chequered history but business now appears to be looking up. The company, which moved from the Main Market to AIM in 2015, reported a 380% rise in revenue in its interim results this morning.

Could this designer and manufacturer of sophisticated electronic components and subsystems for the communications and defence industries now offer better potential returns for investors than blue chip BAE Systems (LSE: BA)?

Business performance up, share price down

Filtronic posted revenue of £21.6m for the six months ended 30 November compared with £4.5m for the same period in the prior year. Pre-tax profit came in at £1.7m compared with a £4.3m loss, and the company moved to a net cash position of £0.8m from net debt of £0.3m.

Despite the strong business performance, Filtronic’s shares are trading 14% down today at 11.75p, as I’m writing.

Lumpy orders

The company cautioned that the phasing of order fulfilment has been significantly biased to H1 and that revenues are expected to be lower in H2. Furthermore, it added: “We are likely to see ongoing short-term volatility in our revenues and profitability”.

However, the lumpiness of orders is something the market should already have been aware of. In the last financial year, four customers accounted for 74% of revenue and in the latest six months, just two customers accounted for over 85%.

The company is well aware of the undesirability of being reliant on a limited number of customers and is working hard to further widen its product and customer base, for which it says it has a “growing opportunity pipeline”.

Higher risk/reward buy

Clearly, Filtronic remains a higher-risk investment but the rewards could be substantial if the company meets the growth that’s forecast by the house broker. This would see a current-year P/E of 23.5 fall to just 9.8 next year.

I see Filtronic as an appealing buy for investors with a higher tolerance for risk and my view is shared by a number of notable small-cap institutional investors whose names grace the shareholder register.

Core buy

Of course, BAE Systems is a Goliath compared with Filtronic. It’s expected to report revenue of £18.6bn for 2016 when it posts its annual results next month and its order book stood at £36.3bn at the last reckoning,

The company’s shares rocketed on the result of the US Presidential Election in November with the expectation that Donald Trump will ramp up military spending. Despite the rise, it remains reasonable value, trading on 15 times expected earnings for 2016 at a current share price of 586p. Unlike Filtronic, the FTSE 100 firm pays a dividend with the yield standing at a respectable 3.6%.

Bottom line

Due to its size, diversification and record of steadily increasing dividends, BAE is a more secure investment than Filtronic. Indeed, I would class it as a core buy for a portfolio.

Meanwhile, Filtronic could produce tremendous capital gains but must deliver on its encouraging — but not guaranteed — opportunity pipeline if it’s to do so.

Lucrative strategy

Including some high-potential small caps alongside core heavyweight holdings can be a lucrative strategy for investors.

The experts at The Motley Fool are always on the lookout for outstanding opportunities in the under-researched lower reaches of the market. And they're confident they've just discovered a grossly mis-priced smaller company.

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G A Chester 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.