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Am I wrong to back this value small-cap because it’s going up?

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I remember reading advice years ago that the worst reason in the world to back a share is because it’s going up. “Oh no,” went the chorus, “You should be buying based on fundamentals and valuations.” And I agree that valuation and fundamental analysis are important.

But the world of investing is full of advice on investing strategy, much of it conflicting. Listen to an investing guru and he or she will tell you one thing, but listen to another and the advice might contradict the first. Of course, in the final reckoning, your investing style and strategy must evolve to become a very personal thing.

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Recovery in full swing

To me, if I like the ‘story’ behind a company, and if the value and quality indicators stack up along with a compelling argument for upside potential, why shouldn’t I buy the share because it’s going up? The ‘going up’ strikes me as a powerful endorsement that the rest of my analysis might be correct.

Well, I like the look of electrical accessories and components supplier Volex (LSE: VLX), and that’s going up. Since its nadir three years ago, the share price is more than 260% higher at today’s 102p. That’s not a bad rate of return, is it? But I think there could be more to come for shareholders.

At first glance, the valuation seems reasonable. The forward-looking price-to-earnings ratio for the trading year to April 2020 stands near 8.6. Then, with the market capitalisation at £150m and the enterprise value close to £131m, it seems Volex has net cash on the balance sheet, which encourages me to believe the company’s financing is in order.

Meanwhile, today’s full-year report reveals trading has been going well. Revenue increased by just over 15% compared to the previous year and underlying diluted earnings per share shot up nearly 43%. The report trumpets that “the recovery at Volex continues,” and the directors anticipate announcing the reinstatement of shareholder dividend payments with the interim results next November.

Better profits and grabbing market share

However, not all the progress is organic. The firm made three acquisitions during the period, which executive chairman Nat Rothchild said in the report “added new customers, capability and geographic presence to the Cable Assemblies division.” 

On top of that, Rothchild explained the firm spent the year ‘refreshing’ its customer base and growing its business with “new and existing customers.” Increased profits mean Volex is in “a much stronger position than it has been for many years.”

The company expects its core markets to “remain highly competitive” in the near term but the firm is driving operational progress with a focus on better execution and gains in market share. Sometimes, I reckon, decent shareholder returns can come from firms operating in sectors that seem unlikely to produce good investments, such as with Volex.

And I can’t argue with the progress of the stock, although I don’t believe we’re likely to see a valuation up-rating. The low-margin, cyclical nature of the business demands a modest rating, in my view. That said, I find the share to be attractive right now. 

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Kevin Godbold has no position in any share 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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