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Is this turbo-charged small cap a better investment than IQE plc?

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Over a one-year time horizon, semiconductor wafer manufacturer IQE (LSE: IQE) has been a fantastic investment. When I covered the stock in early January last year, the shares were trading at around 40p. Today, they change hands for 115p. That’s a strong gain of nearly 190%.

Yet since I looked at the investment case in November, the stock has plummeted over 35%. I warned investors that it was time to be careful, due to the exponential 18-month price rise and the fact that several institutions were shorting the stock. That call looks good in retrospect – those who bought late last year will now be sitting on significant losses.

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With the stock back at 115p, and up 10% today, is now the time to get on board?

Reasonable valuation

For FY2018, IQE is expected to generate revenue growth of around 18%. Earnings of 4.24p per share are forecast, roughly 30% higher than the expected figure for FY2017. That suggests the company’s growth prospects are significant. Given that level of growth, the forward-looking P/E of 27.1 doesn’t look outrageous, to my mind.

Having said that, I won’t be buying the stock right now for one reason: the short interest.

Beware the shorters

In recent weeks, IQE has surged up the dreaded short interest tracker table, to now occupy fourth spot. That means many super-smart hedge fund managers are betting on its price to keep falling. Currently, 11.8% of its shares are being shorted. When a stock is that heavily shorted, you need to be careful. Just looked at what happened to heavily-shorted Carillion shares recently. I’ll be steering clear of IQE for now.

Explosive growth

Given the short interest, growth hunters may be better off looking at £144m market cap Yu Group (LSE: YU). The company provides gas and electricity to small and medium-sized businesses throughout the UK, and has enjoyed a share price rise of 240% over the last year. Are there more gains to come?

A trading update released this morning was very positive, revealing that revenues for 2018 and 2019 are set to be “substantially ahead” of previous expectations. The company announced that operating profits will be ahead of market expectations too, despite increased investments in headcount and fixed costs. Chief Executive Bobby Kalar commented: “The business is developing well and our focus on our long-term sales growth is paying dividends. I look forward to the future with confidence.”

Looking ahead, analysts currently forecast revenue growth of around 50% for 2018, with the top line expected to hit £60.2m. Earnings are also expected to rise significantly. There appears to be strong growth potential here.

However, investors should bear in mind that the stock doesn’t trade cheaply. The forward P/E is currently a high 46, which doesn’t leave much room for error. Having said that, a PEG ratio of around one suggests that the company’s growth rate justifies the lofty valuation.

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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. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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