These small-cap growth stocks could still help your portfolio sing

Shares in online musical instrument and equipment retailer Gear4music (LSE: G4M) were down heavily in trading today as the company’s latest trading update struck a bum note with the market.

Is this reaction, compounding the more gradual fall in the share price over the last few months, a sign to take profits on what had previously been a very lucrative investment for earlier investors (including myself)? Not as far as I’m concerned.

Still on song

Given the problems at other retailers, particularly those with a high street presence, the numbers were still very positive.

Now boasting well over half a million active customers, total sales at the small-cap hit £42.5m in the six months to the end of August — a jump of 36% on that achieved over the same period in 2017. This was ahead of expectations, according to CEO Andrew Wass.

Positively, sales in the UK and abroad were up by close to the same amount (34% and 39% respectively).

In the former, distribution upgrades are “progressing to plan” and should help the company manage a predicted “busier second half of the year” (which, of course, includes the vital pre- and post-Christmas trading period).

The latter was clearly supported by the company’s relatively new distribution centre in Germany where the number of fulfilled orders rose by 230%. That said, growth in Europe reflected a “slower than anticipated build-up of inventory” at its hubs — something Gear4music hopes to tackle in H2 through the expansion of its purchasing team and the move to a higher capacity distribution centre in Sweden.

So why is the stock out of favour today? It’s probably down to talk of “competitive pressures” in the industry and consequences of this on gross margins. So long as sales growth continues and costs are contained — which the company is confident on — there really is no need to panic, in my view. Indeed, talk of opportunities to “rapidly increase” its share of what remains a very fragmented industry only makes me more committed to retaining my holding for at least a few more years.

A forecast P/E of 58 before today is understandably off-putting to all but the most confident investors but — given the potential rewards on offer — I think the valuation shouldn’t be overanalysed at the current time. Assuming the company is able to establish itself as the go-to online destination in its field, what looks extraordinarily expensive might turn out to be a bit of a bargain.

Bearing fruit

If it isn’t for you, how about fellow small-cap Focusrite (LSE: TUNE)? With its memorable ticker, the £280m cap has been a very rewarding stock over the last couple of years, rising almost 200% in value to 470p.

But somewhat ironically, the firm that provides hardware and software products to both professional and ‘bedroom’ musicians makes relatively little noise on the market. April’s half-year figures were the last we really heard from the company on trading. But what a set of numbers they were.

Thanks to growth in all major regions and a strong festive period, group revenue and pre-tax profit rose 21.2% (to £38.8m) and 26.8% (to £5.8m) respectively.

At almost 30 times forecast earnings, the stock is expensive relative to the market in general, but with the company’s strategy now “bearing fruit” (and backed by a healthy looking balance sheet), I think there’s further upside ahead.

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Paul Summers owns shares in Gear4Music. 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.