As long as you pick carefully, small-cap growth stocks have the power to generate far better returns than your average FTSE 100 juggernaut.
With this in mind, here’s one stock that I think should do no harm to investors’ wealth prospects over the medium-to-long term. It could even help them to retire early!
Small-cap, huge growth
Go back a few months and the share price of advanced testing systems designer, manufacturer and supplier AB Dynamics (LSE: ABDP) was riding high. Based on today’s numbers, it’s not hard to see why.
Serving the automotive sector, revenue at the small-cap rose 34% to £34.7m over the six months to the end of February. Positively, 25% of this was recurring, up from 10% thanks in part to contributions from recent acquisitions.
Broken down, the firm achieved strong sales growth in both its track testing and lab testing/simulation sectors (29% and 82% respectively). In line with its push to grow overseas, “particularly strong” performances at its sales offices in the US and Japan were also reported.
Despite these stellar results, AB’s stock was down (very) heavily in (very) early trading. Although surely anticipated, much of this looks to be a reaction to the rather gloomy outlook.
Performance over the second half of the financial year is now “highly uncertain” thanks to the virus. While “a material reduction” in business is yet to be seen, it did say that some larger orders had been deferred. Unsurprisingly, guidance on earnings for the year was withdrawn.
Despite all this, I remain optimistic on ABDP’s ability to weather the storm.
For one, the company is doing exactly what you’d expect to survive this sticky period. Discretionary spending and capital expenditure have been reined in. The interim dividend has also been suspended.
Secondly, it has the sort of finances many firms would kill for. The £340m cap is debt-free and had cash of a little over £35m at the end of February. This is 86% higher than in the previous year.
Third, it’s hard not to be bullish on the small-cap’s prospects considering the ongoing importance of protecting drivers. The increased adoption of autonomous systems surely bodes well for the Bath-based business, once the coronavirus crisis has passed.
Naturally, being an owner of the stock already makes me somewhat biased. The fact that I haven’t even considered selling in the market crash, however, is testament to how confident I am on the likelihood of it generating great returns in time.
Another automotive-related small-cap stock I still won’t go anywhere near, however, is breakdown service provider and insurer AA (LSE: AA).
While AB Dynamics is a clear leader in its niche, the AA continues to operate in a highly competitive environment. Given the low barriers to entry, the alarming drop in new car sales, and the possibility of a long recession, I can’t see how the firm will significantly increase its membership count going forward.
In addition to all this, AA’s balance sheet continues to creak with debt. Why invest in a company with such huge liabilities when there are so many better opportunities elsewhere?
Less traffic may mean fewer callouts for a while. However, I’m very sceptical over AA’s ability to help its investors retire rich.
I suggest Fools continue to steer clear of this value trap.
Paul Summers owns shares of AB Dynamics. The Motley Fool UK has recommended AB Dynamics. 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.