At the moment, with the Covid-19 pandemic still ongoing, and Brexit just around the corner, risks for small-cap stocks, in particular, are high. However, I am willing to accept the risks and have a long enough time horizon to ride out any rough patches. With that in mind, here are two UK small-cap stocks that I would consider buying for December 2020 and beyond.

A small-cap healthcare stock

Hospitals have performed fewer surgeries and procedures this year. For a surgical and advanced wound care small-cap stock like Advanced Medical Solutions (LSE: AMS), this is bad news. Half-year 2020 revenue and profit before tax both declined, by 19% and 62% year-on-year respectively. But things are already getting better in most of the markets the company serves. The recent vaccine developments are encouraging and could potentially end the pandemic sometime next year. Hospitals returning to normal working conditions is a boon for AMS’s sales and bottom line.

Recent developments include two product approvals in India, patents granted in the UK and US for an advanced dressing, and a CE mark being awarded for another. Just yesterday, AMS completed the £22m cash acquisition of a wound care and bio-diagnostics coating business, that was also a key supplier. 

These developments position AMS well for making the most of a recovery in surgical caseloads. Also, shopping for acquisitions and increasing R&D investment to £3.8m this year speaks volumes about AMS’s financial health and management confidence in the medium- and long-term prospects for this UK small-cap stock.

An AIM technology stock

Quartix Holdings (LSE: QTX) is one of Europe’s leading suppliers of subscription-based vehicle tracking systems, software, and services. In January 2020 the company picked up 555 new customers. Then, the Covid-19 pandemic knocked customer acquisition levels down to 200. However, 474 customers were added in September this year, meaning the impact was not as dramatic nor as long-lasting as once feared. All in all, across all markets served, the number of vehicles using Quartix’s products and services have increased so far this year. However, Quartix’s insurance telematics business, which relies heavily on newly insured drivers, slumped, but it does represent only 16% of total revenue.

I think UK small-cap stock Quartix has a lot going for it. Quartix’s customers have had the company’s tracking equipment installed on their vehicles and have learnt how to use its software. Switching to another product is expensive and time-consuming. This suggests customers will stick around. Those customers pay subscriptions for continuing use after installation. Recurring, predictable revenue is great for a growing company.

And Quartix does look good for continued growth. Its customers tend to be owners of fleets of cars and vans. Quartix gives them the ability to locate their vehicles 24/7, make scheduling of deliveries easier, check millage, and report driver locations to their customers. Quartix provides an essential service for customers looking to improve their fleet management. The increase in online delivery is just one trend that is increasing the need for fleet management.

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An expanding market

With a market value of £195m at the time of writing, Quartix is a UK-based supplier of integrated tracking and telematics data analysis solutions for commercial fleets and motor insurance providers. With the global market for these systems predicted to grow at 18.9% between 2018 and 2024 – thanks to development of smart logistics and intelligent transportation systems – Quartix has a probable expanding customer base.

Good cashflow

A current ratio of 1.12 is slightly lower than some investors would like. However, over half the company’s capital on-hand is cash – and only 10% inventory – meaning it can pay its way quickly and easily. In addition, and unusually for a technology micro-cap, Quartix has negligible long-term debt, freeing up cash for investing or dividends.

Notably, Quartix includes money spent on upgrading its fleet business in its sales costs. An accounting technicality perhaps but one that could lower the company’s expected earnings and increase the price-to-earnings (P/E) ratio.

Repositioning for growth

At 31.3 the P/E ratio is lower than the software industry average of 32.2, suggesting that Quartix may underperform its peers. However, during the first half of 2019, the additional investment in marketing and distribution has grown the subscription base by 12% and the overall fleet business market revenues by 11%. 

These gains, though, have been offset by declining insurance business revenues but Quartix is keen to stress the refocussing of the company on fleet operations; only considering the cash-generating insurance business that properly values its offerings. The likely lower earnings for 2019 could put a small dent in the previous five years’ average 10% earnings growth.

Increasing share price…but not assets

Quartix experienced a recent rapid increase in share price – indicating high demand for the stock and further inflating the P/E ratio.  The prior five years have seen Quartix delivering a 163% shareholder return, compared with an industry average of 29.6%, and its return on capital employed, at 46.24p, is impressive.

However, the current stock price could be too high: net tangible assets per share was 1.77 at 268p per share, but the current higher share price of 407p will deflate this figure significantly.

The share price increase also dampens the prospect of an average 3.1% dividend yield since 2015, but a dividend growth rate of 33% for this period is not to be sniffed at. Neither is the dividend policy of approximately 50% operating cashflow. The cash pay-out ratio of 46% signals the dividend is well covered by cash generated within the business.

As an apparently well-run micro-cap in a growth market, Quartix has much potential. But at its current size, it maybe be too pricey for some.

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Two divisions battling it out

The firm started up in 2001 supplying vehicle tracking systems and services to the fleet and insurance sectors. But the story over the past couple of years is that the directors have reviewed operations in the tough insurance market and vowed to “only add new insurance business if the quality of service and product innovation we offer are appropriately valued.”

In other words, management has decided to only take business in the insurance sector if it offers decent profits. I think that decision led to lower volumes from insurance, and when these were flagged to the market, the share price declined to reduce the firm’s valuation. But the valuation was previously high, reflecting the company’s potential to grow, so the stock market’s judgement looks sound given the increased uncertainty in the outlook.

Today’s half-year results continue the narrative. Overall company revenue declined by 3% compared to the equivalent period last year, but within that figure, we can see the firm’s two operating segments battling it out. Revenue from the troubled insurance sector declined by 35% to £2.5m, while revenue from the fleet sector grew by 11% to just over £10m.

If those revenue trends continue, I reckon insurance revenue will become less of a problem anyway. Meanwhile, we are seeing decent top-line growth from the fleet sector, which is flowing in to replace lost revenues from insurance. At some point, it seems likely that fleet revenues could expand sufficiently to produce overall revenue growth for Quartix, which means the drift up in the stock could make sense.

Strong cash flow

Although diluted earnings per share declined by just over 17%, the company delivered good news on cash flow, which I think underlines the attractions of the business model because it generates recurring revenue and subscription-based income. Cash from operations rose 5% to £3.5m generating free cash flow of £3.2m, which is up 12%.

The great thing about free cash flow is that a firm can use it to pay dividends to shareholders, and the directors announced an interim dividend of 2.4p, which is the same as last year’s payment. The policy is to set total dividends for the year at around 50% of cash flow from operations, which strikes me as a sensible approach. However, the directors will also consider additional special dividend payments to distribute “the excess of cash balances over £2m.”

There are some impressive double-digit percentage figures in the report for new fleet installations and subscriptions. My view is that the growth story is alive and kicking, albeit in the temporary shade of lacklustre performance from the insurance sector. Is this an opportunity for investors? Maybe. At the recent share price of 277p, the forward-looking earnings multiple for 2020 is around 23 and the anticipated dividend yield is close to 4%. I think it’s rare to find such decent growth-potential married to a chunky dividend, so for me, the stock is attractive.

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At the present time, for example, the stock market is still relatively high despite its recent pull-back. Therefore, there are a number of stocks which appear to be overvalued and that offer narrow margins of safety. Those companies could lead to capital losses for new investors and avoiding them could lift the performance of an individual investor’s entire portfolio.

With that in mind, here are two stocks that could be worth avoiding at the present time. Both appear to be overvalued based on their profit forecasts.

Positive outlook

Reporting on Tuesday was subscription-based vehicle tracking specialist Quartix (LSE: QTX). It released a trading statement that showed it is on track to deliver on management expectations for the full year. It has made progress in its core fleet business in the US and France since the start of the year. New installations in those countries in the first quarter of the year are due to be 60% ahead of the same period in the prior year.

The company’s strategy has contributed to its improved performance. And while there are pricing pressures across the insurance telematics market, they are not expected to have a material impact on its first-half results. In the second half of the year, however, it anticipates that insurance volumes could come under pressure. This is likely to be why its shares have moved 6% lower after the update.

Despite its lower stock price, Quartix continues to trade on a price-to-earnings growth (PEG) ratio of 6.5. Given the challenges it is seeing in some of its markets, this seems to be an excessive valuation. As such, it could be a stock to avoid at the present time.

Limited growth

Also offering a valuation which is stunningly high at the present time is IT infrastructure specialist Softcat (LSE: SCT). The company has a solid track record of growth, with it having increased its bottom line by between 9% and 15% in the last two financial years. This rate of growth is expected to continue in the next two years, with its bottom line forecast to rise by 12% this year, followed by 8% next year.

While the company’s rate of growth is relatively impressive, it appears as though investors have become overly optimistic about its investment potential. The stock trades on a price-to-earnings (P/E) ratio of around 28, which suggests that it is grossly overvalued at the present time.

Certainly, we are in the midst of a positive period for the stock market. While there has been a pull-back of late, growth in recent years has been exceptionally high. However, even putting Softcat’s valuation into perspective suggests that it could offer limited capital growth. As such, it could be the right time to sell it, rather than buy it.

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To satisfy my craving for growth and income, I’ve hunted through the market and found two stocks with growth ratings and yields of more than 3%.

Investing in tracking

Not all drivers are keen on having a black box in their car tracking their behaviour. But telematics are increasingly a fact of life, especially in the fleet sector.

One company that’s positioned to profit from this trend is telematics supplier Quartix Holdings (LSE: QTX). This £177m firm is focused on supplying tracking technology to the fleet sector, but is also expanding into the insurance sector, when it can do so without sacrificing margins.

Figures released today show that sales rose by 5% to £24.5m in 2017, while pre-tax profit rose by 1% to £6.6m. These modest gains were largely the result of more selective bidding for insurance work. The total dividend was increased by 20% to 13.5p, supported by a higher cash balance of £7.3m.

International growth could explode

The number of vehicles under subscription rose by 20% to 105,314 units last year, but a 23% increase in fleet installations was partially offset by a 17% decline in insurance installations.

Most of this volume growth was in the UK, but Quartix is also expanding fast in France and the USA. Vehicles under subscription rose by 32% to 13,131 in France last year, while the equivalent figure rose by 45% to 8,973 in the USA.

As the company already has more than 80,000 vehicles under subscription in the UK, I’d imagine that the potential market in the USA is many times this size. I believe overseas growth could transform this business over the next few years.

Looking ahead, the stock trades on a forecast P/E of 29 with a prospective yield of 3.5%. I believe Quartix remains a decent long-term growth opportunity.

Invest in younger customers

Young drivers are helping to fuel the growth of telematics-based insurance. Younger customers are also a key part of the growth story for my next stock, hostel-booking service Hostelworld Group (LSE: HSW).

Modern hostels are increasingly popular with young travellers who like their affordable rates, central locations and well-equipped communal spaces. Shares in this £366m firm have risen by 72% over the last year.

Hostelworld confirmed in January that its 2017 results should be in line with expectations. Based on broker consensus forecasts, this means that sales will have risen by around 10% to €87m, while adjusted earnings will have risen by around 5% to €0.21 per share.

This may seem relatively modest growth for a company which trades on a forecast P/E of 20. However, Hostelworld is expanding into the Asian market, where bookings rose by 18% during the first half of last year. This region should make a bigger contribution to earnings going forward.

Another attraction is the group’s dividend policy, which is to pay out 75% of adjusted earnings each year. Strong cash generation has made this policy both affordable and sustainable and the forecast yield has now risen to 3.7%.

In my view, Hostelworld could be a great buy for long-term income and growth.

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Leading supplier

The Welsh technology firm is a leading supplier of compound semiconductor wafer products for use in smartphones and other electronic devices. Founded in 1988 by chief executive Dr Drew Nelson, IQE has grown through acquisitions to become a £950m company. It now boasts an international client base, with a global market share of more than 50%.

The AIM-listed company has clearly gone from strength to strength over the years. It has increased sales in each of its three primary markets and sees multiple promising growth opportunities ahead. Adjusted earnings per share have expanded rapidly from 1.86p in 2011 to 3p last year, while revenues have nearly doubled from £75.3m five years ago, to £132.7m in 2016.

IQE is set to release its 2017 interim results on 5 September. Ahead of its results, the company announced that it expects to deliver revenues of around £70m. What’s more, in addition to revenue growth of about 11% for the six months to 30 June, City analysts expect earnings to climb roughly 13% from the same period last year.

Valuations

Although expectations for the firm’s near-term revenue and earnings growth are certainly impressive, valuations seem stretched after the recent rally in its shares. Based on this year’s expected adjusted earnings per share of 3.23p, shares of IQE trade at a forward P/E of 42.7. And even after factoring-in estimates of a further 17% increase in its bottom line, its forward P/E would fall to a still pricey figure of 37.1 by next year.

The semiconductor maker may have much working in its favour, but it’s not the only UK-listed technology stock promising long-term growth potential.

A better buy?

Small-cap vehicle tracking specialist Quartix Holdings (LSE: QTX) may be relatively unknown to most investors, but I reckon the up-and-coming technology firm is a great share to own for the long term.

The company is a leading supplier of vehicle tracking systems and services to the fleet and insurance sectors. Its award-winning vehicle tracking service helps firms improve operational efficiency, by enabling them to stay on top of vehicle activity. Quartix also makes driver-monitoring telematics equipment, which is used by insurers to provide increasingly popular ‘black box’ car insurance policies.

Things are going well for the company’s fleet business, with installations up 45% to 14,324 in the six months to 30 June. Its customer base increased by 11% to 10,076, while customer attrition remained relatively low, at 10.1%. On a less positive note, insurance installations fell by 35% on the same period last year, reflecting the company’s recent shift in strategy to focus on higher margin business, instead of pure volume growth.

Quartix seems more sanely valued, with shares trading at 30 times its expected earnings this year and 26.5 times its forecast earnings in 2018. These are still higher valuation multiples than the market average, but for those hunting long-term value, this is probably the place to be. The firm has a solid business model with plenty of growth potential and a prospective yield of 2.2% to boot.

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After reading and re-reading today’s numbers, I can’t help but think this reaction is overdone. Here’s why.

Flat profits

Over the six months to the end of June, revenue came in at £11.5m — a small reduction on that achieved in the same period in 2016. Pre-tax profits were also pretty much flat at £3.2m, compared to £3.3m in H1 2016. While some holders would have hoped for better, that’s hardly the stuff of nightmares.

On an operational level, it reported “excellent progress” in its main fleet business with revenue rising 15% to £8.3m and vehicle subscriptions increasing to 10% to just under 97,000. The number of fleet installations also rose by a very encouraging 45% to over 14,000 with recurring revenue rising 16% to £7.6m. Attrition rates were significantly below the industry average.

Growth in customer numbers was seen in all markets with rates of 9% and 12% achieved in the UK & Ireland and France respectively. While still a relatively small part of the business, the number of US clients signing up increased 20% over the six month period.

Now for the less good news.

As a result of a planned move away from its lower-margin insurance business, revenue from this part of Quartix fell 27% to £3.2m with the number of installations falling 35% to just under 24,000. According to Managing Director Andy Walters however, this move will lead to a “more acceptable balance in margin” between the two parts of the business. He went on to reflect that, notwithstanding the unpredictable nature of its insurance business, the company would use any additional income generated to invest in its fleet operations.

Falling knife?

Today’s substantial fall in the share price needs to be put into perspective. Since coming to market towards the end of 2014, shares in the Cambridge-based company have still climbed over 140% even after taking this negative reaction into account. That’s a pretty healthy capital return in anyone’s book.

Indeed, Quartix seems to have become the victim of its own success in the sense that investor expectations appear to be ahead of reality. Any announcement from a growth-focused company that states it is on track to meet profit expectations rather than beat them — such as that announced today — was always likely to be punished by the market.

Assuming investors can look beyond the short term, however, I still reckon Quartix warrants attention. A quick scan under its bonnet shows a company particularly adept at deploying cash with returns on capital almost tripling between 2011 and 2016. The relatively low amount of capital expenditure also means that levels of free cashflow — while declining by 16% to £2.6 over the reporting period — remain decent. Income investors may also be attracted by Quartix’s intention to distribute the excess of cash balances over £2m as a supplementary dividend. 

To be h0nest, I think today may have presented prospective investors with a great opportunity to climb on board, even if — thanks to their sustained rise — Quartix’s shares are unlikely to be cheap on conventional measures (trading at a vertigo-inducing 33 times forward earnings before this morning’s numbers were revealed).

Strange as it may sound, today’s drop may actually be a blessing in disguise.

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Since 2012, the company’s revenue has grown from £52.6m to £82.6m and pre-tax profit has risen from £10.8m to £19.1m. Meanwhile, earnings per share have jumped from 5.4p to 7.8p. City analysts are expecting further growth in the years ahead. The company is projected to report revenue growth around 10% to £92.4m for 2017 and then further growth to £103m for 2018. A pre-tax profit of £25.5m is expected for 2018, up 150% from 2012’s figure of £10.8m. 

In a trading update issued today, management confirmed the company is on track to hit these targets as Advanced Medical grows through both acquisitions and organically.

Worth paying the price? 

Unfortunately, thanks to the company’s defensive nature and impressive growth, its shares are quite expensive. 

Based on current city forecasts shares in the company trade at a forward P/E of 33.9 and earnings per share growth of only 10% does little to justify this lofty valuation. The dividend payout of 1p per share for a yield of 0.3% is hardly a reason to buy either. 

Still, the one redeeming feature is the company’s hefty cash balance. At the end of 2016, Advanced Medical reported a net cash balance of £51.1m, up 49% year-on-year and equal to just under 10% of the company’s current £600m market capitalisation. Over the past five years, shares in the company have returned 330% excluding dividends.

Overall, if you’re looking for a highly defensive growth stock with more cash than it knows what to do with, and a record of producing returns for shareholders, Advanced Medical seems to be a great investment. Even though the shares might seem expensive, as Warren Buffett once said, “it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.“

Explosive growth rate

Quartix Holdings (LSE: QTX) looks to be an early stage Advanced Medical. Over the past five years, the company’s revenue has started to pick up, rising from £15.3m to £23.3m for 2016. Pre-tax profit has increased by £1.5m to £6.5m and earnings per share have grown from 8.5p to 12.9p. Pre-tax profit is expected to hit £6.7m this year before rising to £7.7m for 2018, and earnings per share are projected to increase to 13.5p over the same period. 

According to a trading update issued by the company this week, management believes that Quartix is on track to hit City forecasts for growth this year with new installations of its vehicle tracking systems growing by 40% during the six months to 30 June. With over 14,300 vehicles already using the group’s tracking systems, there is clearly a huge market out there for the tech. 

As management continues to pursue growth opportunities, investors should reap the rewards from further growth. Shares in Quatrix currently trade at a forward P/E of 32.6.

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A broad customer base

The company reckons more than 10,000 fleet companies are using its vehicle tracking system, a figure growing at around 130 companies per month, which is a fair clip suggesting plenty of ongoing growth potential.

You’ll find the firm’s customer companies and organisations operating in sectors such as building, construction, excavation, and all the building services contractors as well as transportation-related firms such as truckers, taxis, patrol vehicles and many others. Back in the 1990s and early noughties I used to run an engineering services firm with a fleet of vehicles and it would have been useful to manage the operation with Quartix’s technology and services. I suspect demand will remain robust for some considerable time.

The firm says that trading has been “consistent with achieving market expectations for the year as a whole.” City analysts following the firm have an 8% decline in earnings per share pencilled-in for 2017 and a rise of 14% for 2018, so the firm seems to be on course to hit those figures.

Preserving margins

Underlying operational progress seems robust. New installations of tracking systems jumped up 44% to 14,300 vehicles during the past six months and the firm has 97,000 active vehicle subscriptions across its markets in the UK, France and the US. A recent shift away from low-margin insurance business to concentrate on the core fleet business is going well. The directors vow to “continue to invest in our fleet business in the second half and only add back insurance volume where our quality of service and product innovation mean that we can command attractive margins.”

With such a focus on controlling the quality of margins, I’m optimistic that Quartix can grow profitably from here and see the firm as well worth your further research as a potential long-term growth investment.

A shift to mobile delivers

Meanwhile, half-year results from Taptica International (LSE: TAP) aren’t due until the end of August, but we do know that the firm has been growing fast providing a global end-to-end mobile advertising platform for ad agencies and brands.

Back in March, the firm reported strong full-year results saying that 2016 was the first full year as a mobile-focused business. Mobile delivered 86% of revenue during the year, driving the overall figure for turnover up 66% compared to the year before, and earnings per share shot the lights out with a near 700% rise.

More to come?

Looking forward, City analysts following the firm reckon earnings per share will put on another 31% this year and 7% during 2018. The growth story remains on track and the directors reckon the company continues to gain traction with existing and new household-name clients, such as Amazon, Disney, and Expedia. Most of the company’s revenue originates in the US but a “meaningful contribution” came from the Asia-Pacific region last year too.

I think there is much more to come from Taptica and recommend you aim your investing radar in the firm’s direction for further research.

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Improving performance

Reporting on Friday was defence and aerospace company Rolls-Royce (LSE: RR). It announced that its business units are performing as expected ahead of its results for the first half of the year. Its strategy seems to be working well, with the company on track to deliver improving financial performance over the medium term. For example, its focus on increased production, as well as cost-cutting, could have a positive effect on margins and lead to a rising bottom line in future.

In fact, Rolls-Royce is forecast to report a rise in its net profit of 28% in the next financial year. Given that the FTSE 100’s growth rate is typically in the mid-to-high single-digits each year, this means that the company could be growing at a rate which is four times that of the wider index.

Despite this, it trades on a relatively enticing valuation – even after its share price rise of 36% since the start of the year. It has a price-to-earnings growth (PEG) ratio of only 0.8. For a blue-chip share with a diverse business model, this seems to be a very low price to pay. With spending on defence likely to rise across the globe as the developed world exits austerity programmes, now could be a prudent time to buy Rolls-Royce for the long term.

Potential catalyst

Also offering a bright outlook is vehicle tracking specialist, Quartix (LSE: QTX). It has experienced an impressive recent period, with the company recording two successive years of double-digit earnings growth. In fact, its net profit has risen at an annualised rate of 22.5% between 2014 and 2016, with more growth expected to be reported next year.

Quartix is forecast to report a rise in its bottom line of 14% in the next financial year. Although it trades on a price-to-earnings (P/E) ratio of 32.6, it could offer share price gains even after its shares have soared by 19% in the last six months. The company’s current strategy seems to be working well, and this could lead to a fast-rising and more consistent earnings growth outlook over the medium term.

Furthermore, Quartix could become a highly desirable income stock. At the present time it yields 3.3%, which is 40 basis points ahead of inflation. With the potential for a higher level of profitability in future, dividends per share could rise significantly and make the stock relatively appealing from an income perspective. This could catalyse its capital growth prospects, as investor demand for income shares may rise due to higher inflation.

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