Two small-cap dividend-growth stocks I’m watching closely

As small investors, how can we compete with the vast resources pumped into stock research by City firms? One choice is to focus on companies that are too small to attract much institutional interest.

The beauty of this approach is that if you’re willing to do your own research, you have a real chance of uncovering some genuine bargains. Today I’m going to look at two profitable small-cap stocks to see if either deserves a buy rating.

Watching the profits

With a market cap of about £35m, AIM-listed Synectics (LSE: SNX) is too small for most funds. This 30 year-old firm specialises in advanced surveillance and security systems. Key customers include oil and gas companies, casinos, transport operators and public authorities.

Today’s full-year results show that revenue fell by £0.8m to £70.1m during the year to 30 November. However, despite flat sales, adjusted pre-tax profit rose by 15% to £3m. Underlying earnings rose by 22% to 15.2p per share.

Stronger cash generation helped to lift the group’s net cash balance from £2.2m to £3.8m at the end of the year, enabling the board to raise the final dividend by 50% to 3p per share. This gives a total payout of 4p per share for the year, equivalent to a yield of about 2.1% at current levels.

Should we be betting excited?

Synectics business is quite lumpy, depending on periodic big orders. These can boost earnings in one year and depress them in the next.

According to management, gaming profits are likely to slow this year, while those from transport could rise. Oil and gas is expected to remain depressed for another year. Overall, the board expects profits to be broadly flat in 2018.

The share price has fallen by 10% today on this downbeat outlook. This has left the stock trading on a forecast P/E of about 13, with a prospective yield of about 3%. In my view this looks like a decent company, but I would prefer to wait for a sharper sell-off before considering an investment.

Faster growth elsewhere?

If you’re looking for a stock with a stronger track record of growth, one alternative might be CML Microsystems (LSE: CML). This Essex-based semiconductor firm produces two main lines of products, solid state storage and radio frequency communications chips.

Both product lines cater for growth sectors of the market, which helps to protect profit margins. Spending on research and development is consistently high, supporting future growth.

A strong recovery

After hitting some stumbling blocks in 2014/15, CML has returned strongly to sales growth. Sales rose from £22.8m to £27.7m last year and are expected to climb by around 15% during the current year.

The picture is less clear when it comes to profit growth. Analysts’ consensus forecasts for the current year suggest earnings of about 23p per share, broadly in line with 2016/17. This puts the stock on a forecast P/E of 23, with a prospective yield of 1.6%.

In my opinion, this could be an attractive growth stock with good long-term potential. CML’s balance sheet is strong and the group’s 15% operating margin is attractive.

On the other hand, I think the current valuation is quite demanding when compared to earnings growth. This is a stock I’d be more tempted to buy during a market correction.

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Roland Head has no position in any of the 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.