Could these 2 bargain small-cap stocks make you a million?
Shares in engineer Avingtrans(LSE: AVG) are sliding today after the company reported its results for the year ended 31 May.
And while the headline figures were disappointing, I believe that this is the perfect opportunity for long-term investors to get involved in the group's growth story.
A transformational year
For the year, Avingtrans reported sales growth of 7% to £22.7m and adjusted earnings before interest, tax, depreciation, and amortization of £0.7m, up 104% year-on-year. Adjusted profit before tax was £0.3m, compared to 2016's figure of £0.1m. Unfortunately, after including costs, the company reported an unadjusted loss of £0.3m.
However, during the year, it overhauled its business model and going forward I believe that the company can generate huge returns for investors.
After selling its Aerospace division for a healthy profit in 2016, and returning £19m to investors, management has decided to adopt a strategy it calls "Pinpoint-Invest-Exit," based on the "now proven strategy of 'buy and build' in regulated engineering niche markets." This looks similar to the model used by engineering giant Melrose, which buys businesses, helps them reach their full potential, and then sells them on.
As part of this strategy, Avingtrans made modest acquisitions of Scientific Magnetics and the assets of Whiteley Read Engineering during the financial year. After the year-end, the company acquired Hayward Tyler Group. According to management, "an unfortunate combination of ambitious investment programmes, acquisition and market down-cycle led HTG to an overstretched balance sheet position." Avingtrans hopes to be able to get the business back on track and growing again.
Buying, building and selling can be lucrative if done correctly. That said, plenty could go wrong with such a strategy and investors need to keep an eye out for the tell-tale signs that management has bitten off more than it can chew.
If the firm's sales growth starts to slow, costs expand rapidly, and cash generation vanishes, these could be signs that the problems at HTG may be deeper than initially believed. On the other hand, if costs fall, sales continue to grow, cash generation improves, and margins widen, Avingtrans should be heading in the right direction.
Slow and steady
Castings(LSE: CGS) is three times the size of Avingtrans, so the company's growth is slower than that of its smaller peer. Nonetheless, I still believe that this business can achieve stellar returns for investors.
Since the beginning of 2015 the shares have produced a total return of 45%, and as long as the company can maintain its operating profit margin of 14% and return on capital employed of 14%, the returns should continue.
Wide margins and a high return on capital mean that the company has been able to invest for growth and return cash to investors at the same time. Book value per share has grown at around 6% per annum for the past six years, and at the end of fiscal 2017, Castings had net cash on the balance sheet of £27m. The shares currently trade at a forward P/E of 15.8 and support a dividend yield of 3%.
As long as Castings' business continues to throw off cash, I would not rule out the prospect of additional special dividends.
The power of dividends
Both Avingtrans and Castings are focused on returning cash to investors, which is great news for shareholders.
Indeed, investors often overlook the power of dividends, and how they can improve your portfolio's performance.
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Rupert Hargreaves does not own any share mentioned. The Motley Fool UK has recommended Castings. 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.