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Why I think this top small-cap stock could make you a fortune

Markets are very volatile so it’s a good time to take a long term view of the stock market. One stock that I think has a very bright future is Bioventix (LSE:BVXP). It manufactures antibodies that are used to measure hormone levels in blood to detect underlying health problems. These are used by equipment providers such as Siemens in hospitals and they pay for the product as well as giving royalties of around 2% of the cost of the test when the antibodies are used. The main activity of the company is to develop and supply these antibodies.

Small team, big profits

It’s a very small but very profitable operation founded by Cambridge science graduate Peter Harrison. Since the company was AIM listed in 2014 the share price has risen a whopping 450% as profits have risen from £1.8m to £5.6m. The interesting thing with Bioventix is that it has barely expanded in this time. Most of the increase in profits has come from royalty payments for products that it developed years ago. The same effect should be seen with products that it is working on now that are unlikely to have a positive impact on revenues for at least five years due to the extensive testing required.

As a result of this very small operation (15 employees) and high profits from royalty payments, the company has a staggering operating margin of 78%. The long period of legacy payments also means that products that are developed should generate huge returns in the future, but over a long period of time. This has resulted in an industry-leading return on capital employed (ROCE) of 62%. This measure of quality is highly regarded by Nick Train, one of Britain’s most respected investors, as I explained here. In my earlier article I talked about the significance of ROCE, and why it is so important for revenue growth. And more good news for Bioventix is that every new product that it releases improves this return.

Good income and growth

The high operating margin generates the company a lot of cash and with little need to expand operations, it pays a dividend of 2.5%, which is increasing. However the company only aims to keep around £5m in cash and will pay a special dividend if it has extra lying around. This brings this year’s dividend up to around 4%.

The downside for this stock is that a company of this quality doesn’t come cheap. It has fared well during the recent sell-off following decent results in October which have supported the share price. It currently trades on a price-to-earnings ratio (P/E) of 27 which seems fair to me, but does leave buyers with a degree of valuation risk. However in present market conditions I think there is reasonable downside risk with virtually all companies regardless of performance. For me then, this is an ideal buy-and-hold investment. I would put the ups and downs to one side and watch this company increase its returns.

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Robert Faulkner 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.