2 small-cap recovery stocks that could make you brilliantly rich

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Rhythmone

Buying recovery stocks is difficult. One reason for this is timing. Buying a company that has experienced difficulties too early could lead to short-term paper losses for an investor. Similarly, buying once a recovery has taken hold can mean that the market has already priced-in its potential. As such, there seems to be a 'sweet spot' where a company is still in its early stages of recovery, but its outlook remains somewhat uncertain. These two companies appear to be at that stage and could therefore be worth buying right now.

In-line performance

After a number of profit warnings and a vast decline in its valuation, defence company Chemring(LSE: CHG) seems to be making encouraging progress. It reported a positive trading update on Tuesday which showed it is performing in line with expectations. Revenue in the last four months has increased by 13.4% versus the comparable period from last year. Its order book of £541.8m was 2.6% lower than it was at the end of April 2017, but recent orders provide the company with confidence about its prospects over the medium term.

Of particular note for investors is the improving performance of the company's countermeasures segment. Orders totalling £56.6m were received during the period, with operational performance improving and the second Philadelphia plant having been successfully closed. Similarly, there has been a robust performance from its energetics and sensors segments.

Looking ahead, Chemring is forecast to post a rise in its bottom line of 10% in the current year, followed by further growth of 9% next year. Despite this upbeat outlook, it trades on a price-to-earnings growth (PEG) ratio of just 1.6. This suggests that it could deliver a rising share price over the long run.

High growth/low valuation

Also offering recovery potential is online advertising company RhythmOne(LSE: RTHM). It announced news of an acquisition on Tuesday which could see it become a complete end-to-end platform in one of the fastest-growing segments of its industry. It has agreed to acquire YuMe for a total consideration of $185m based on current exchange rates. The deal will be funded through a mix of cash and shares (one-third cash, two-thirds shares) and is expected to close in the first calendar quarter of 2018.

The acquisition fits with RhythmOne's strategy to create a unified marketplace that is efficient and effective for advertisers. YuMe offers innovation within the video advertising segment and this could complement the programmatic platform that RhythmOne has built over the last three years. During that time, the company has been transformed and is now expected to deliver a positive bottom line for the first time since 2014 in the current year.

Despite its clear recovery prospects, the stock trades on a low valuation. Next year it is expected to report a rise in its earnings of 168%, which puts it on a PEG ratio of only 0.1. As such, now could be the perfect time to buy it.

Making a million

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Peter Stephens has no position in any of the shares 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.