The stock market is generally fairly good at pricing in companies' growth prospects. But from time to time it's possible to find businesses whose growth potential has been underestimated.
Today I'm going to look at two firms I believe could grow much faster than expected over the next few years.
A growing market
Sales of own-brand consumer products in supermarkets have been rising steadily for years. But have you ever wondered who makes these products? In Europe, one of the market leaders is FTSE SmallCap firm McBride (LSE: MCB).
This group specialises in household cleaning and personal care products, and supplies many of Europe's biggest retailers. Today McBride announced the acquisition of Danish firm Danlind, which should increase its foothold in the dishwashing and laundry markets.
Management expects the deal to result in "significant commercial, technical and operational" cost savings. No figures were provided, but the group did say that Danlind was expected to generate earnings before tax, interest, depreciation and amortisation (EBITDA) of £2.5m this year on a standalone basis.
Given that McBride is paying a total of £38.8m for Danlind, this gives the deal an effective valuation of 15 times EBITDA. That's a fairly full price in my view. Indeed, management admits that while earnings will rise immediately, the deal's post-tax return on invested capital won't rise above McBride's cost of capital -- essentially its borrowing costs -- until the third year of ownership.
Despite this caveat, I'm positive about the outlook for McBride. I believe the market for good quality own-brand products is likely to keep growing. For example, in Eastern Europe the market share for private label is currently about 20%, according to McBride. That's a lot less than the 40% level seen in the UK.
McBride has made big improvements in profitability over the last few years. It's now focusing on growth. The shares trade on a reasonable 13 times 2017 forecast earnings and offering a 2.4% yield. I believe long-term investors could enjoy significant profits.
Too cheap to ignore?
If McBride is affordable, I believe Character Group (LSE: CCT) could be plain cheap. This £100m company specialises in making branded toys under licence. Examples of the group's brands include Peppa Pig and Marvel.
Growth has slowed this year after a strong run. This has pulled the group's share price back from a high of 550p, to today's price of about 480p. But I think this sell-off may have gone too far.
This business is extremely profitable. The group generated a return on capital employed of 58% in the 2015/16 financial year. This means that cash generation is very strong, and Character has had net cash on its balance sheet since 2015.
Earnings are expected to have risen by 6% during the year ended 31 August. Further growth of 8% is expected during 2017/18. The shares also offer a forecast dividend yield of 3.8%, which should be well covered by free cash flow.
For all of this, investors are being asked to pay a forecast P/E of 9.3, falling to a P/E of 8.7 for the year ahead. In my view, that's probably too cheap. I believe Character Group could be a profitable buy at current levels.
Don't ignore this small-cap star
If you're looking for cheap small-cap stocks with big growth potential, I believe you can't afford to ignore 1 Top Small-Cap Stock From The Motley Fool.
This exclusive new report contains details of a company our top investment experts believe could be worth up to 66% more. This business is 'under the radar' for most investors at the moment, but this situation could soon change.
If you'd like full details of this potential buy, download this free, no-obligation report today. To get your copy, just click here now.
Roland Head owns shares of McBride. 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.