Famed US investor Peter Lynch said the greatest stock-research tools were our eyes, ears and commonsense. Half the battle for investors was buying companies they understood and forming a considered view on the quality of their product or service.
I learned this the hard way with JB Hi-Fi when it floated in 2003 at $1.55 a share for retail investors. Your columnist recalls being 10-deep in a JB Hi-Fi queue, compact disc in hand, thinking the store had a great format, and that customers could not get enough of its gadgets.
Did I buy? No! Concerned about the retail outlook at the time, I avoided the IPO and early aftermarket in the company, only to watch this great retailer hit a 52-week high of $21.45. Those who bought or sold JB Hi-Fi based on retail conditions missed the point.
Your columnist had more luck with ResMed Inc and the much smaller SomnoMed. As a mild sufferer of sleep apnoea, I have been tested in sleep clinics and own a Resmed Continuous Positive Airway Pressure (CPAP) machine and its nasal-pillow mask.
Like many sleep apnoea sufferers, I am non-compliant. Air blowing into the nose or mouth all night is too uncomfortable and the machine seems noisy and hot. Some friends rave about ResMed products and have no difficulty using them throughout the night.
This non-compliance sparked my interest in SomnoMed, a maker of dental stgices that treat sleep apnoea. Another friend who struggled with a CPAP machine used SomnoMed’s stgice, similar to a mouthguard, and has not looked back. I think about trying it, but no longer find sleep apnoea a problem (it’s amazing what exercise and going to bed earlier can do!).
This column featured ResMed and SomnoMed in July 2014 in “Small Caps Riding a Big Trend.” ResMed was $5.94 and SomnoMed $1.48. ResMed has rallied to $8.22 and SomnoMed has soared to $2.95 after reporting a strong interim profit in February.
Chart 1: ResMed Inc.
Chart 2: SomnoMed
Both companies are benefiting from the rising incidence of obesity and more people being diagnosed with sleep apnoea, a potentially life-threatening condition that involves repeated episodes of airway obstruction during sleep. Symptoms include daytime drowsiness.
ResMed stands out. It is an exceptional company; one of Australia’s best, in my view. Cochlear and CSL typically get medical stgices/lifescience plaudits, but do not discount ResMed. It has excellent profit margins, well-received products, recurring income from mask upgrades and replacement masks, and a history of innovation.
Even after recent share-price gains, ResMed does not look expensive as its outstanding AirSense 10 flow generator beats market expectations for sales.
SomnoMed’s rally has been particularly pleasing. This well-run medical-stgice company stayed below the market’s radar for years, despite building a genuinely global business and having a strong product in a growth market.
SomnoMed reported a 21 per cent lift in units sold to 24,775, an 18 per cent growth in revenue to $14.8 million, and a whopping gross margin of 68.5 per cent for the first half of FY15. Underlying earnings were slightly positive as it continues to reinvest funds to grow the business.
Guidance for the second half of FY15 impressed. It expects unit sales to grow 30.5 per cent for the full year, revenue to grow 35 per cent and underlying earnings of $2 million.
SomnoMed’s global footprint is valuable. United States sales are growing strongly, it is entering new markets in Europe this year, it expects to maintain strong growth in Japan, and is targeting Korea. Always look for small-cap companies with capacity to expand overseas. Growth opportunities in a small market such as Australia can be limited.
Having raised $7 million in August 2014, SomnoMed has plenty of cash to fund its growth strategy. I like small-cap companies that grow by reinvesting surplus cash flow, rather than taking on large debt or continually raising equity capital and diluting investors.
This column wrote in July last year: “I doubt SomnoMed’s $66 million valuation adequately captures the value of a company that has a well-received product on the market, a solid foothold in several offshore markets and potential for sharply higher sales growth in coming years.”
Now with a $153 million market capitalisation, SomnoMed is finally being recognised, but that valuation still does not capture the long-term potential. Even so, SomnoMed is best bought on weakness when some heat comes out of the recent rally. It suits investors comfortable with small-cap stocks and higher risk tolerance. The current valuation leaves little room for disappointment.
Tony Featherstone is a former managing editor of BRW and Shares magazines. This column does not imply stock recommendations. Readers should do further research of their own or talk to their adviser before acting on themes in this article. All prices and analysis at March 4, 2015.