I first heard of the Hong Kong based RC Group (London Stock Exchange: RCG) from the Growth Company Investor magazine and after some analysis of this company, their shares seemed like a possible good buy. However, I was aware the price may be temporarily high as it was just recommended in the magazine that week, so I put it on a watch list to hopefully catch a buy in opportunity. And boy did I get it! The price reduced from around 75 to 47p for no material reason. I did some further analysis on it and bingo, I thought it was a good investment. I’m not too keen on many recommendations in the magazine but occasionally it helps you find a gem that isn’t overpriced.
RC Group manufacture and sell technology for facial and fingerprint recognition along with RFID products. The company is making money and has a market cap of £75 (25 Aug 2006). Turnover was 15.2m and profit before tax was 4.82m for the year ending 31 Dec 2005. Price to earnings was approximately 10.6 when the price was 47p in early Aug 2006. So it looked cheap if it could demonstrate sustainable growth potential.
Warren Buffet says he only considers company’s where he believes growth will be over 15% year on year. He also says he can get a return of 50% on one million dollars on a year guaranteed. I can only think he can do this through smaller cap stocks with growth rates of over 40%. Using the company guidance and analysing their previous reports, I estimated RC Group could grow eps by 50% this year. All at a p/e of 10.6. Also, on the 21st June 2006, the company issued a bullish trading statement, stating that sales and profit were ‘significantly ahead of market guidance’. I was becoming convinced I had found a stock unloved and at a great price. Another bonus is that no analysts follow it – yet…
I did my own financial spreadsheet and everything looked in order. One point I noted was a declining operating margin which was worrying, but explainable due to the move to more product based revenue. However, forecasted operating margin is still high of around 30%, though dropping from 54%. They have also raised 11m cash through a private placement in Oct 2005 so there is a worry they spend this unwisely. Indeed they have bought a pc distributor and a casino tech company, which they explain will help them penetrate more markets, but I wonder if it’s the correct strategy, or is it slight deworsification, a term coined by the legendary investor Peter Lynch. I’m going to monitor this in the future. They also have no long term debt.
Do they have a sustainable competitive advantage? I think so at the moment but I’m not sure. It depends how commodity like these items become. I’m still going to invest but keep an eye on ever shrinking margins. I can see this company being good for the next 5 years. I have invested £13,780 at an average price of 51.94p. A big holding yes, but why not when you’re as sure as you can be. I also know that the interim results are coming up soon at the end of September, so it should provide some more market recognition and added thrust to the share price.
That was a finepick. The stock is rising nicely, however as it’s a small cap, the spread can be pretty bad. But it looks a good candidate for a long term investment.