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An 88% increase in underlying earnings! Should I buy this small-cap stock now?

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Halfords (LSE: HFD) may be a well-known retail brand. But the company is only a small-cap stock with a market capitalisation of about £533m. And a year ago, many investors avoided it like the plague.

How Halfords became a low-value small-cap stock

The stock had been locked in a downtrend since the middle of 2015. And that move was driven by static revenue, erratic normalised annual earnings and declining cash flow in the underlying business. Many were questioning the relevance of the long-established motoring products and vehicle service business. Bricks-and-mortar outlets seemed so last-century in today’s online world.

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And when the coronavirus pandemic arrived, Halfords landed hard at the bottom of the spring stock market crash. In March 2020, the shares were changing hands near 50p – a far cry from the more than 550p they reached in August 2015. By most measures, the company had been a disastrous investment for shareholders who were in the stock for the long haul.

But astute investors seeking value and buying the stock near the bottom of the crash have been amply rewarded since. Halfords turned out to be a Covid-19 winner when demand for cycles exploded during the lockdowns. And much of the customer engagement began with the firm’s website. The stock performed an impressive handbrake turn and shot back up. Today, it’s at 260p as I write, giving those bottom-fishing investors multi-bagging returns in a matter of months.

A remarkable turnaround

And today’s half-year results report for the six-month period to 2 October 2020 reveals the justification for the stock’s upwards move. Like-for-like revenue rose by almost 7% and underlying earnings per share shot up by just over 88%. However, I’m cautious about Halfords now. Although these results are stunning, my guess is the company may not have moved instantly from tired old value stock to sexy growth share. We could be seeing something of a Covid-induced bubble in trading. Indeed, City analysts have pencilled in decreases in earnings ahead. And I think it is informative that the directors have declined to pay an interim dividend.

Looking ahead, the company reckons the outlook for the second half of the current trading year is uncertain given the seasonality of our business and the ongoing impact of Covid-19.” Chief executive Graham Stapleton said in the report the firm has worked hard to capitalise on “tailwinds” in the cycling market. But in the motoring market, there have been “headwinds”. He reckons UK traffic is around 30% lower than pre-Covid-19 levels and the company has been affected by the government’s MOT deferment policy.

An emerging long-term growth story?

But in the vehicle servicing business, the firm’s ‘Road Ready’ campaign and prior investments have enabled an increase in market share and growth in the second quarter. And building on that success, Halford’s is in the process of recruiting for a wide range of service-oriented roles with an emphasis on the growing electric vehicle market.

I think Halfords has been a triumph for brave, value-seeking investors this year. And there could be a long-term growth story beginning to emerge in the business. But I’m watching the stock from the sidelines for the time being and hunting for other shares to buy 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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