We often pin our hopes on small stocks hoping to make it big. On underdogs. But the reality of the stock market is that the most reliable way to make money is often to invest in companies that are already profitable and successful.
A promising start
Small-cap Shield Therapeutics (LSE: STX) floated on the AIM market last year and currently has a market cap of £183m. Shield's plans certainly sound promising. The group's main product is Feraccru, a treatment for iron-deficiency anaemia. The company is actively marketing Feraccru in Europe and has secured patent protection until 2035 in a number of markets, including the US.
Today's half-year results provide an insight into progress. H1 revenues were £142,000 and the group reported a net loss of £9.6m. However, the company had net cash of £21.5m at the end of June, so there's no imminent risk of a cash shortage.
According to management, the group's strategy is to licence Feraccru in non-core markets and market it directly in major markets such as the UK. The company currently has 20 sales staff "driving product recognition and sales" in Germany and the UK.
Pack sales are said to have increased by 375% in Germany between December 2016 and July 2017. In the UK, growth over the same period was 184%.
The company is looking forward to the results of a phase 3 clinical trial in early 2018. If the results are as expected the company hopes to gain regulatory approval in the US. According to chief executive Carl Sterritt, this could increase the potential market opportunity for Feraccru from 330,000 patients to "upwards of 2.5m patients".
It all sounds promising. But as investors we also need to consider the firm's valuation. In today's results, Shield reiterated its guidance for annual sales of £20m-£25m in 2020. My concern is that the group's current market cap is already £183m.
This guidance means that in three years from now, the stock may still be valued at more than seven times sales.
This sky-high valuation seems to carry a high risk of disappointment. I won't be investing.
An unlikely double-bagger
Shield Therapeutics may strike it lucky and attract a takeover bid. But I'd rather put my money into a proven performer.
Shares of British American Tobacco (LSE: BATS) have doubled since 2010. During the same period, the group's dividend payout has risen by 50%. Patient shareholders have enjoyed a market-beating capital return and a generous dividend income.
Big-cap stocks don't always perform this well. But BAT's share price has now fallen by 17% from the all-time high of £56.40 seen back in June. The shares are starting to look more reasonably valued, in my view.
Earnings are expected to climb by 14% to 282.4p per share this year, and by a further 11% in 2018. Dividend growth is expected to be around 9% in both years -- well above inflation and average wage growth.
These forecasts put British American Tobacco on a 2017 forecast P/E of 16.5, with a prospective yield of 4%. The recently-completed acquisition of Reynolds is expected to result in cost savings that should support margins. For investors wanting real returns on their investments, I believe BAT could be a profitable buy.
Roland Head 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.