Spectra Systems (LSE: SPSY) is a small-cap growth stock that I’ve followed for a number of years. Recently, the share price has underperformed and is down almost 8% this year alone. However, this does mask a 500%+ return since the end of 2016.
Today, I’m looking at this growth stock again to see if I should buy more shares for my portfolio. Let’s take a closer look.
The business
Spectra Systems is a leader in providing security technology, including software and advanced materials. Its core revenue generation comes from authentication and processing of banknotes.
Spectra’s banknote authentication technology is top secret as it’s used by global central banks, including two G7 banks. While it authenticates at Level I and II – public level authentication – Level III is the covert one. This has to be unbreakable as it needs to prevent state-sponsored counterfeiting. For example, a foreign country flooding another country’s economy with fake banknotes.
There’s some caution here because of the increase in use of digital payments (not to mention cryptocurrencies). This may impact SPSY’s banknote authentication revenues in the future. However, as the technology is used at Level III authentication, as long as there are any banknotes in circulation then there’s a risk of state-sponsored counterfeiting. It means the firm’s tech will still be required.
The company also offers various other brand security services for a wide range of consumer products and lotteries.
Attractive fundamentals
For being a small-cap growth stock with a pipeline of development opportunities, the company achieves very strong financial numbers. For example, the most recent gross margin was a high 69%, and the operating margin an impressive 36%.
It’s is cash generative, and is able to pay a respectable dividend. The current dividend yield is 4.6%, which I consider attractive considering it’s investing in its development pipeline too.
Recent results show growth stock characteristics
The company released its interim results in September that were in line with the board’s expectations. Revenue grew 23%, and adjusted earnings per share rose by a huge 45%. Cash on the balance sheet increased to $12.8m, which was up from $10.9m. The company is on track to achieve record earnings for the full year.
Since the interim results, it announced that one of its longstanding central bank customers placed a new order as part of another five-year renewal agreement. Based on this renewal, results should now exceed market expectations for the year. The share price has fallen since this release, so I don’t think the market is pricing in the potential for Spectra Systems.
Is this growth stock a buy?
Because of the small size of this growth stock, it flies under the radar of research analysts and institutions, which means it’s hard to get accurate forecasts. It might be considered as higher-risk due to the lack of research on the stock, but I see it as an opportunity. Spectra Systems has recognised the lack of research into the company and recently appointed Allenby Capital to provide extra brokerage and analysis.
I think this growth stock will outperform in 2022 if the market prices the shares correctly for the growth ahead. There’s a risk that rising digital payments limit its banknote authentication business, but SPSY is diversified across other sectors. It’s a buy for my portfolio.
Dan Appleby owns shares of Spectra Systems. 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.
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