Where to find big profits in small companies

A professional investor tells us where he'd put his money. This week: Edward Wielechowski of Odyssean Capital chooses three overlooked minnows.

At Odyssean we attempt to apply in-depth research to stocks to identify promising long-term stories that are poorly understood and therefore undervalued by investors. We believe such bargains are most frequently found among smaller companies. Stocks in this segment of the market tend to get limited coverage from brokers, so few investors are fully familiar with them.

As a result, price movements can become disconnected from company fundamentals. What's more, small caps are more likely to be able to deliver a sharp improvement in performance than their larger counterparts. A new market opportunity or management team can drive meaningful change in returns .

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A defensive firm in transition

Chemring (LSE: CHG),

In 2018, the group's sensor divisions secured a significant boost from long-term US military programmes. These new contracts have the potential to transform the profitability of the group. Furthermore,the recently installed CEO instigateda strategic review, discontinuingvolatile and less profitable ammunition supply operations.

It is slowly becoming a higher-margin, more predictable business, focusing on products that help save lives. With peer Esterline recently sold for around twice sales, and Chemring currently trading on approximately 1.4 times earnings, the shares are highly attractive.

Navigating the cybersecurity landscape

NCC (LSE: NCC)

However, the new management has identified significant margin and cash-generation improvement potential through internal efficiencies as well as opportunities to accelerate growth in the key US market. These measures have started to deliver and have further to go, presaging strong earnings growth over the medium term. Given all this, we believe the current valuation of about 12 times earnings is too cheap.

Skin in the game

Devro (LSE: DVO)

A period of investment in new production facilities is now beginning to bear fruit. Furthermore, management has identified cost savings through integrating a historically globally disparate group and trimming costs. Improving cash generation and increasing profitability supports a dividend yield of around 6%. The market has overlooked the stock or dismissed it as boring, but we see a real opportunity here for long-term investors.