2 quality small-caps that could rebound strongly in 2017

The Motley Fool
Image: Public domain
Image: Public domain

2016 has been a difficult year for investors. While the portfolios of many may be worth significantly more than they were in January (when the FTSE 100 was below 6,000), the journey taken to get there has been rather testing. Indeed, if there's one thing we've all learned after two seismic political events, it's to expect the unexpected.


So it's unsurprising if some small-caps have fared worse than their traditionally-less-risky blue chip counterparts. Among those companies that have seen their share prices dip over the last year have been healthcare software and services supplier EMIS(LSE: EMIS) and photobooth operator, Photo-Me International(LSE: PHTM). Could these stocks get back on track in 2017? I think so and here's why.

In need of resuscitation?

EMIS doesn't generate many column inches, yet it plays a significant role in our lives. The £541m cap is often the first choice of GPs, hospitals and pharmacies up and down the UK for digitising patient records and providing IT solutions. The fact that EMIS already has a significant share of this market makes it highly attractive as an investment. After all, it's simply too much hassle to switch IT systems regularly, especially if you're dealing with something as important as healthcare.

So why the drop from the all-time high of 1,155p back in January to today's more subdued 860p? Although the aforementioned flight from more risky shares can't be overlooked, cuts in NHS spending and a reduction in the number of acquisitions have clearly hurt sentiment towards the stock. Will this fall continue? Given the benefits that come from implementing the company's software (reduced operating costs, improved patient services), I'd be very surprised.

On a forecast price-to-earnings ratio (P/E) of 16 for 2017, shares in EMIS aren't screamingly cheap when compared to other stocks on the market. They are, however, considerably less expensive than they've been in the past, leading me to also consider the company's potential as a bid target.

Picture perfect?

Bookham-based Photo-Me International is another small-cap whose share price has been heading in the wrong direction of late. Since reaching a 16-year high of 178p back in March, shares in the £538m cap have dropped back to 140p. I suspect this may be short-lived, particularly as the company stands to benefit substantially from the continued implementation of the My Number identity card scheme in Japan. The potential need for 3D images in the future could also act as a catalyst for growth.

There are other things to like about Photo-Me. The company can boast excellent levels of return on capital in recent years along with rising operating margins. Its net cash position is also a major positive. But perhaps the biggest draw is the generous yield on offer. As things stand, Photo-Me is expected to pay out just over 7p per share to investors in 2017, equating to a yield of 4.91%. That's an awful lot more than you'd get from a typical savings account.

The only thing that concerns me here is the dwindling dividend cover. Next year, it's expected to drop to 1.17. This shouldn't be a problem if Photo-Me's earnings recover over time, of course, but it's certainly something for income investors to ponder before snapping up the shares.

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Paul Summers has no position in any shares mentioned. The Motley Fool UK has recommended Emis Group. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.