If you’re looking for higher investment returns, it can pay to have a little bit of exposure to small-cap stocks in your portfolio. Small-caps are generally riskier than large-caps – just look at what has happened to Sirius Minerals recently – however, pick the right stocks, and you could boost your wealth significantly. With that in mind, here’s a look at one exciting smaller company I believe could provide strong returns over the long term.
Keystone Law (LSE: KEYS) is a next-generation law firm with a unique, technology-driven business model. Unlike traditional law firms, Keystone hires lawyers who work from home, or from their own offices. The company then provides these lawyers with all the administrative support they need from its Central London head office, while taking a cut of the revenues generated.
I think this is a really attractive business model because it’s so scalable – Keystone currently has around 300 lawyers on its books but, given that its lawyers work remotely, what’s to stop it having 3,000? In fact, the company says its addressable market is potentially 47,000 lawyers, which suggests there’s plenty of room for growth.
Speaking of growth, Keystone has expanded substantially in recent years (it has grown its top line by 104% over the last three years) and September’s half-year results showed further progress. For the six months to 31 July, revenue increased 15.3% to £23m, adjusted profit before tax jumped 15.4% to £2.7m, while basic earnings per share climbed 14.5% to 6.3p.
In addition, not only did the group declare an ordinary dividend of 3.2p, but it also rewarded investors with a special dividend of 8p. CEO James Knight said the results provided “clear evidence of the group’s ability to scale” and also advised that the performance underpinned its confidence in the second half of the year.
Aside from its prolific growth, there are a number of things that impress me about Keystone Law. First, return on equity (ROE) is high – this metric has averaged 25% over the last two years. In other words, Keystone is a very profitable company.
Second, cash flow is strong and the dividend payout is growing. The recent special dividend suggests to me the stock could turn out to be a cash cow. Third, the balance sheet is robust with minimal debt on the books. Overall, I see Keystone as a high-quality company.
I’ll also point out that founder and CEO James Knight owns a large chunk of the shares, meaning management’s interests are likely to be aligned with shareholder’s interests. That’s another big plus, in my view.
I’m a buyer
On the downside, the shares aren’t exactly a bargain. With analysts forecasting earnings per share of 14.5p for the year ending 31 January, the forward-looking P/E ratio is 34.7, which means there isn’t a huge margin of safety.
However, given the attractive growth story and the group’s high-quality attributes, I don’t see the high valuation as a deal-breaker. With the stock still very much under the radar, I think it’s a good time to be buying.
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Edward Sheldon owns shares in Keystone Law. 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.