Really Cheap Small-Caps For Brave ISA Investors

Published in Investing on 25 August 2011

Three ideas with lowly P/Es.

So once again I've been trawling the market for cheap bargains and this time I'm presenting three small-caps for brave investors.

The trio of ideas I've selected all trade on the main market, so they're eligible for tax-friendly ISAs. I don't know about you, but I do like to shelter my shares within ISAs so I don't have to worry about paying tax on my capital gains or extra tax on my dividends. 

Anyway, cheap shares are often cheap for a reason, and I think it's pretty obvious why the market is currently cautious about these three ideas. But sometimes the fear can be overdone, and I don't believe any of the shares are heading for the knacker's yard just yet. Perhaps just a lack of bad news and a re-rating from today's lowly P/Es could help them each deliver a very worthwhile return.

Here are the three shares:

Nose dive

First up is Flybe (LSE: FLYB), which claims to be Europe's largest regional airline. By 'regional' I take it to mean flying to out-of-the-way airports you'd have to be desperate to visit -- such as Doncaster. The company joined the stock market late last year and the shares have since tumbled from 285p to 145p, which now supports a £109m market cap.

Results in June showed a mixed picture, with revenues up 4%, passenger numbers flat at 7 million, profits thumped by volcanic ash and heavy snow, and no sign of a dividend. But the airline does trade with net cash and forward ticket sales are currently up 6%. With Flybe also expecting 2012 profits to match those of 2011, I reckon the P/E is about 7.

School's out

Next is RM (LSE: RM), a £84m supplier of computer equipment to schools. As you can imagine, government cutbacks are a problem here and May's interim results admitted sales had slumped 15%. Hints of a profit warning and a "comprehensive strategic review" were then issued in July. Complicating matters even further is RM's decision to change its year-end, which might cause suspicions among seasoned punters.

Right now, investors are pinning their hopes on RM's prominent sector position, a reliable dividend record -- the annual payout has advanced five-fold since the mid-90s flotation -- and a dirt-cheap valuation. You might have to adjust for a possible profit warning, but at 90p, the trailing P/E is less than 6 and the dividend yield tops 7%.

Headline figures

Finally I have Smiths News (LSE: NWS), which is the country's largest wholesaler of newspapers and magazines. The obvious headwinds here are declining circulation figures and hard-pressed newsagents, which combined to trim interim sales by 5% within Smiths' last results. But cost-cutting lifted profits by 11% and the dividend by 8%, and there are further efficiencies to come.

This business carries £57m of net debt, which might worry some when annual profits are less than £40m. But a market cap of £153m looks to discount that and all the other risks, with a trailing P/E of less than 6 and a dividend yield of 8.7% at 83p. I must also give Smiths a bonus point for favourable executive nomenology -- the chief exec is Mark Cashmore.

What now?

As I say, cheap shares are often cheap for a reason, but I don't believe any of those three companies are on the verge of bankruptcy just yet. 

You'll need to be brave to buy of course, but sometimes very handsome returns can be made from written-off companies that surprise everyone with a bit of positive news. If you have any better suggestions, please let me know in the comment boxes below.

Happy bargain hunting!

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> Maynard used to live near Doncaster Airport.

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Sianwill 25 Aug 2011 , 10:35am

Agree with RM tip apart from the massive imminent change with how ICT is delivered in schools. BECTA was disbanded suggesting the present government does not see ICT in schools as important and needy of so much money. How mcuh longer will schools need on site servers and where will VLEs be in two years time? Could be that schools go to Google+ or other cloud computing solutions and cut down the need for upgrades to network infrastructure etc. Will students be using their own devices in the classroom. RM is a great company and should be able to move with the times but also has many detractors in the education sector - often ignorant people who do not know enough about running IT. I hope they do well but the uncertain future for ICT in schools is a problem for me. I suspect they could make a mark internationally though - replicating what they have done in this country.

Jimi97 26 Aug 2011 , 6:06pm

IMO, Sir Humphrey would say it's a 'courageous' investor who invests in an airline.

palflat 26 Aug 2011 , 8:31pm

OK nice article about small-caps, but there is no need to be rude about Doncaster, have you actually been there?

RobinnBanks 28 Aug 2011 , 3:49pm

The oldest British Classic horse race has been run at Doncaster since Anthony St Leger, who lived nearby, devised the race in 1776. Run in September, that is where the most famous investors' maxim comes from: 'Sell in May and go away; buy them back St Leger Day.'
It stems from when the POSH (with port out, starboard home abbreviated on their luggage trunks) did the Grand Tour of the Med during the summer months; but returned to Doncaster for the Classic in September.

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