Three top micro-cap stocks

Each week, a professional investor tells us where he’d put his money. This week: Richard Power of Octopus Investments.

The FP Octopus UK Micro Growth Fund aims to provide capital growth via a portfolio of 50-80 smaller companies that we believe are capable of substantial growth. New additions to the portfolio tend to have a market value of less than £100m when we invest, and we will continue to hold those investments until we believe that their potential has been realised, although, of course, capital is always at risk with any investment, and you may not get back what you originally invested.

The value of smaller companies can rise or fall by more than larger companies listed on the main market of the London Stock Exchange, and may also be harder to sell. Our main hunting ground at Octopus Investments is the Alternative Investment Market (Aim). It has evolved over the years to be the go-to market for growth companies, and today boasts a good selection of high-quality businesses. Below I highlight three examples.

Firstly, we like data-analytics company First Derivatives (LSE: FDP). Its high-volume database software, Kx, has already seen the business grow strongly in the financial-services sector. Meanwhile, as data complexity grows in other industries, the business is increasingly well placed to benefit from big technology trends, such as blockchain, machine learning and cloud computing.

First Derivatives is also winning business in the media, retail, pharma, telecommunications and utilities sectors. Some of its high-profile customers include Red Bull Racing and Nasa. While the shares trade on a high rating, we think earnings could go much higher than the market currently expects.

Gear4music (LSE: G4M) is the UK’s largest retailer of musical instruments and equipment with a strong online presence. It’s a great example of a small, ambitious company using Aim to become a dominant force in a very fragmented market. G4M raised £9m at the time of its initial public offering (IPO) in June 2015, at which time it was generating sales of £24m from its York showroom.

It used the proceeds to expand into Sweden and Germany and is now expected to generate turnover of £81.1m for the year to February 2018, increasing to more than £100m in 2019. The European musical instrument market is worth an estimated £5bn. G4M currently has a market share of just 1.5% – so there’s huge opportunity here.

More recently, we have invested in Everyman Media Group (LSE: EMAN), an operator of premium cinemas across the UK. Everyman currently operates in 21 locations and is expanding quickly with cinemas in York, Newcastle, Glasgow and Liverpool expected to open during 2018. The company’s management team is focused on creating a distinguished brand with industry-leading profit margins, boosted by its food and drink offering and customer experience.

The company will be driving its expansion programme over the next few years, and we expect it to more than double in size over that period. With current market share of less than 2%, we see potential for substantial growth.