Regular readers know this column spends plenty of time on investment megatrends and finding the best stocks to benefits from social, economic or demographic change. The key issue, of course, is company valuation, but the right trend is a powerful place to start.

This column’s favoured megatrends include the coming middle-class consumption boom in Asia; massive global urbanisation; the Internet of Things; the emerging markets’ tourism boom; and more recently, the smartphone revolution and mobile internet in stgeloping economies.

But I keep coming back to two enduring megatrends: the ageing population and the obesity epidemic. The effects of an ageing population are becoming more noticeable by the day. Three aged-care facilities, one offering five-star accommodation, are under construction within two kilometres of my house. This trend will have a profound effect within a decade or two.

Sadly, the global obesity crisis shows no signs of easing. I see more children who are glued to TV, computer, table or smartphone screens, either their own or their parents’. Many exercise less than previous generations and eat more fast food as takeaway consumption rises.

These trends have influenced coverage of two small-cap stocks in this column: medical-stgice distributor LifeHealthcare Group and SomnoMed, a maker of oral stgices for sleep apnoea. I’m also loathe to present companies as “favourites” because it can blindside one to valuation (every stock has its price) and is a sure-fire way to lose money in the long run.  But I rate both companies’ prospects and believe they have further to run in the medium term.

LifeHealthcare group was covered in this column in May 2014 at $2.25 a share and again in January 2015 at $2.58. I wrote in January: “One can envisage faster growth as LifeHealthcare increases its customer base of ‘active surgeons’ and distributes more implantable stgices, such as orthopaedic and prosthetic products, amid an ageing population.” LifeHealthcare Group is now $3.51, having peaked at $3.92.

Chart 1: Lifehealthcare Group

Source: Yahoo

To recap, LifeHealthcare raised $76.6 million through an Initial Public Offering on ASX in December 2013 at $2 a share. Founded in 2006 through six acquisitions of medical-stgice companies, it distributes high-end medical stgices in Australia and New Zealand and works closely with surgeons, hospitals, nurses and other medical specialists. It is superbly leveraged to the ageing population as more people need orthopaedic surgery.

LifeHealthcare’s interim result in February impressed. Revenue grew by 15 per cent and underlying earnings by 19.6 per cent in the first half of 2014-15. This column foreshadowed strong growth in implantable stgices as the company signed up more surgeons and distributed more products through new and existing customers. It did not disappoint.

Management guidance for full-year revenue and underlying earning was low double-digit growth. Astute acquisitions will also boost earnings.

The key to LifeHealthcare is growth in the number of surgeons who use its products and revenue per surgeon. The company continues to add more active surgeon customers, and revenue per surgeon has grown 65 per cent since FY10. It is a strong business model: attract more surgeons who influence hospital purchases, sell more products to each surgeon over time, and produce rising, annuity-like revenue.

Watch this data on surgeon customer numbers and average spend when LifeHealthcare reports its full-year result later this month.

At $3.51, LifeHealthcare trades on a forecast Price Earnings (PE) multiple of about 17 times earnings and should yield about 4 per cent. That’s getting up for a $147 million company, but is not excessive given its double-digit growth trajectory and market position.

After strong price gains, LifeHealthcare Group is due for a bigger pullback or consolidation. The full-year result could provide a buying catalyst if it beats guidance for low double-digit growth. But is hard to gauge market expectations: LifeHealthcare is barely covered by analysts and too small for most fund managers to invest in. It has a low market profile, despite excellent long-term prospects, and therein lies the opportunity.

Like LifeHealthcare Group, SomnoMed is going from strength to strength. More people are using its oral stgices to treat sleep apnoea and it is expanding rapidly overseas. About 48 per cent of revenue is earned in the US, 41 per cent in the UK, and the rest in the Asia Pacific. The one-year total shareholder return is 52 per cent to August 5, 2015.

I first covered Somnomed for The Bull in July 2014 at $1.48. It has rallied to $2.95, having peaked at $3.20.

Chart 2: SomnoMed

Source: Yahoo

SomnoMed in July reported a strong end to its latest financial. Fourth-quarter sales rose 21 per cent year on year, breaking records in the company’s three key markets.  Few Australian small-cap industrial companies have this type of sales momentum and global footprint, or an opportunity in such a large, growing market as more people with obesity suffer life-threatening sleep apnoea.

Somnomed is still making losses as it reinvests heavily, so suits experienced investors comfortable with higher risk. It trades on a revenue multiple below similar medical-stgice companies in the United States, but needs to keep posting high sales growth, and in time start to  convert it into profits, to justify the rising valuation. So far, so good.

>> BACK TO THE NEWSLETTER: Click here to read other articles from this week’s newsletter


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 August 5, 2015.