Three small cap growth stocks
In the current “risk on” environment investors are looking at the more speculative investments with a glass is half full view. But if you do take the plunge, it’s important to know what you’re letting yourself into. First up, I cover four stocks we think have growth criteria: they can grow faster than the market. You have to remember that there are only so many companies that can grow at rapid rates sustainably. The Amazons, the Facebooks of this world are an anomaly.
Fortunately, when you’re small, the world is big. Growth is possible at faster than average rates. But you have to know when to fold! First I cover four stocks that have that growth potential, there stocks having appreciated quite a bit since we first tipped them. Then I look in detail at another, in order to give you an idea of how to invest.
Growth Stock 1: Hazer (HZR)
Hazer is at the most speculative end of Under the Radar’s risk spectrum. The company’s intellectual property relates to the processing of biogas from water waste treatment plants, turning methane into hydrogen and graphite. Methane’s chemical structure is comprised of one carbon atom and four hydrogen atoms. Hazer’s process teases each out to make hydrogen for use as a low emission source of energy, as well as synthetic graphite (carbon), which has industrial uses in electric vehicles through powerplants and batteries.
Growth Stock 2: SomnoMed (SOM)
Considering that dental activity has been restricted to essential operations during the fourth quarter, SomnoMed’s revenue showed great resilience. The company makes an oral device to treat sleep apnoea, which is fitted by a dentist. It is important to remember how global SomnoMed is, operating in 28 countries, with sales in Europe, the company’s largest market, North America and APAC. SomnoMed is also launching a new product for North America, its second digitally made, Medicare insurance approved, oral appliance.
Growth Stock 3: Splitit (SPT)
This is the Israel based baby brother of the BNPL giants Afterpay (APT) and Zip Co (Z1P). Its proprietary intermediate payment technology utilises the credit card providers’ authorisation via the merchant to allow the customer to easily buy now and pay later in instalments at no cost. The process is similar to what happens when you check in to a hotel and your credit card is used to authorise an amount without actually charging it. Purchasers incur no interest charges or fees payable to the merchant or to Splitit. Normal interest and fees applicable to customers’ credit card still apply. Splitit makes money from transaction fees charged to merchants which use its service.
CASE STUDY: Vmoto (VMT)
Our experience with Vmoto, a Chinese based electric scooter manufacturer provides some good lessons. Its stock has sky rocketed almost 6 fold since the sell off in mid-March, going from 10 cents to over 60 cents. “Blue sky” comes to mind because who doesn’t want an electric scooter in the COVID-19 world of restricted travel?
But it’s been quite a journey as they might say on The Voice. We’ve been covering it since early 2014 when it showed some promise, climbing close to current levels, only to fall into a funk for the next six years, until now.
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Step 1: Keep stakes small in highly speculative companies
Such companies, which involve high risk, have the potential to burst into life very quickly. The takeout is that it’s prudent to hold a position of size that you can carry. This might be 1% of your portfolio. You cannot afford to leave 10% of your portfolio dead for 10 years. The opportunity cost of other ideas is too high.
Personal investors have the luxury to hold underperforming stocks for the long-term. Fund managers, whose jobs are on the line if they’re not beating the market, don’t. This has always been the case, but it’s more so today, considering the structural shift of active to passive investing (index funds).
Step 2: Be Patient!
You’re first investment thesis might not go as planned, but that doesn’t mean you sell out.
Back in 2014 we liked Vmoto because it had built a 30,000sqm facility in Nanjing and had a licence to manufacture electric scooters. The factory had capacity of 300,000 units a year, had a production agreement to manufacture bikes for a privately owned Chinese company named PowerEagle, was one of the first movers in a market that was taking off, its product being aimed at the premium end and was already cash flow positive.
Three years in it became obvious to us (and as it turns out management) that the PowerEagle manufacturing contract was costing Vmoto more than it was bringing in. The company was making more scooters but losing money, as the lower-margin PowerEagle vehicles chewed into the bottom line. The positive was international, but back in 2017 they were selling about 3,500 units, which as we said at the time, wasn’t going to trouble Honda’s or Vespa’s top brass.
Being patient means that although there was a great deal of bad news, the spectre of hope in the much higher margin international markets was worth holding on for, despite the capital raising risk. We’re glad we did! We downgraded to Hold in early 2018 and kept watching for more signs of life.
Step 3: Embrace change
Under founder/CEO Charles Chen the company has thrown off the Chinese market to fully focus on the lucrative international sales, which is having big results. Just after we downgraded, Vmoto did a transformational deal with China based Super Soco, combining forces to sell product offshore and raised $2m in equity capital. It also nabbed a marketing opportunity with Volkswagon to brand a Vmoto Cux electric scooter under the high end Ducati label.
This has translated to higher volume at higher profit margins, which is the kind of volume Under the Radar was originally looking for. In 2018 the company sold just under 11,000 units for a little under $20m; the following year it sold 20,000 units to deliver $46m in sales and is on track to exceed $50m in the current year.
Step 5: Look through short-term pain
When we ran the numbers again earlier this year, COVID-19 was running hard in China and a nervous investor may have bugged out. In fact, Chinese supply chains have held up and is the key to why Chinese products are so much cheaper to build. Telsa recently built a factory in Shanghai.
Vmoto is meeting the increased demand in export markets. The most recent quarter showed increasing scooter sales, this time delivering positive operating cash flow. Since the start of the pandemic, Vmoto has continued to put distribution agreements in place around the world and has received additional volume from sharing operators, which is very encouraging, supplying seven operators globally and is in advanced conversations with a further 12. Vmoto is also in discussions with an additional 10 potential B2B customers in food and parcel delivery.
Vmoto’s potential is limited only by product performance and price. If you hang on and exercise patience, there are more Vmoto’s out there.
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