3 stocks that passed my basic small cap screening test

There are 1,910 companies listed on the ASX, according to the ASX Company Directory. Even if we exclude companies with a market capitalisation of over $10 billion and under $5 million, that still leaves us with over 1,500. For any individual investor, staying on top of even 5% of those is a nearly impossible task.

So, of course, we need to whittle down the list a bit – well, a lot actually.

Research indicates that the incremental benefits of diversification fall away sharply beyond around 15 stocks for small cap investors. This is good news, as in my experience, following more than about 20 stocks closely (i.e. holdings of significance), and another 20-30 from a distance (i.e. small holdings and watchlist) is impractical for most people who aren’t full-time investors.

So how do we whittle down the list? We use a screening test.

There are many online tools that allow you to do this, but in my experience, they are unreliable when it comes to ASX small caps. My preferred approach is to start with a range of idea sources, including:

• The reports of high-performing fund managers
• Trusted friends and acquaintances (provided they know what they’re doing)
• Companies I am a customer of
• Discussions in the media – like in an article like this one.

But even when something catches my eye, it still needs to pass a basic screening test (even if it came as a personal recommendation from Warren Buffett) before I’ll decide whether to devote hours of my time to research.

The five elements of my basic ASX small-cap stock screening test are:

1. The company must be profitable, or at the very least, have a clear pathway to profitability in the short term.
2. The share count must not be rising precipitously. As a rule of thumb, I like to see less than 10% dilution over the last 3 years, although I am willing to make an exception when the company has a good reason for the dilution.
3. Revenue must be growing.
4. A strong balance sheet (I prefer to see net cash on the balance sheet, but exceptions can be made when the cashflows or assets backing the debt are extremely reliable.)
5. At least one year of positive normalised free cash flow, defined as operating cashflow, less operating expenses run through financing cashflows (like lease repayments) and less investing cashflow, but excluding genuinely one-off investments.

While these may seem pretty basic (that’s the point after all), it’s shocking how few companies make it this far. But again, that’s the point – I don’t want to spend every minute of my free time researching ideas!

Now that you know my initial process, here are three companies that recently passed my basic ASX small-cap screening test.

#1 – Mayfield Group Holdings (ASX:MYG)

Mayfield Group provides electrical and telecommunications products and services for utilities, infrastructure, data centres, and green energy projects, among others. It has recently won several large contracts (as I covered in the first episode of our new podcast The ASX Small Cap Wrap). The longer term theory is that it will benefit from the growth in data centres and distributed energy generation.

Mayfair Group generated extremely strong positive free cash flow in the 2024 financial year, but it actually burned cash in H1 FY 2025. While the trailing twelve months’ free cash flow is very strong, Mayfair Group passes this test. However, it does highlight how free cash flow can be lumpy; and after its recent special dividend, its balance sheet is not quite as strong as before.

Key stats:

• Market capitalisation – $94 million
• H1 FY2025 net profit (NPAT) – $5.1 million
• Growth in share count (last 3 FYs) – 2.3% p.a.

At a glance, Mayfield Group seems fully priced to me, but I do note that it holds significant deferred tax assets on its balance sheet. As such, its tax is currently a non-cash expense and this could be a source of hidden value given the board’s track record of paying out dividends when possible. If the theoretical tailwinds drive demand growth, and the company can control costs more effectively, I could easily see Mayfield Group grow into its current valuation..

#2 – Kinatico (ASX:KYP)

At first glance, I thought this was a company I’d never looked at before. However, on closer inspection, I realised it was formerly known as CV Check (ASX: CV1); a company that had undertaken multiple capital raisings leading to an explosion in the share count.

However, I was pleasantly surprised to see that the company now passes the 3-year dilution test (having stabilised itself more recently).

Between FY16 and FY24, Kinatico’s revenue grew from $7.1 million to $28.7 million. It achieved positive statutory NPAT for the last two financial years, and the share count has actually fallen since the end of FY21. Debt is minimal, and it had $10m in cash at the end of H1 FY 2025. After four years of achieving positive operating cashflow, it finally achieved positive free cashflow in FY24.

As for the business itself, Kinatico’s new(ish) platform ComplianceX appears to be an evolution of the original CV Check software. Essentially, it helps employers with the hiring, onboarding, management, and offboarding of employees. This includes tasks like verifying credentials, ensuring completion of training, tracking performance, and terminating access when an employee is leaving.

There’s a wide range of potential outcomes, which provides both risk and opportunity, but with the stock currently at three-year highs, the stock price seems to be on a positive trajectory.

Though I must say, the claim that “[ComplianceX] changes the management of the workflow of your people as Uber did for rideshare and Canva did for design2” feels hyperbolic to me.

Key stats:

• Market capitalisation – $73.5 million
• H1 FY2025 net profit (NPAT) – $416,347
• Shrinking share count over the last 3 years.

#3 RPMGlobal Holdings (ASX:RUL)

RPMGlobal provides software to resources companies that helps to manage mining projects. What makes it particularly interesting is the recent divestment of its advisory business.

Simply looking at its top-line revenue, the company achieved no growth between FY15 and FY21, before almost doubling it between FY21 and FY24. However, this high-level view masks interesting developments under the hood.

Firstly, RPMGlobal’s advisory business – the one they just sold – has very inconsistent revenues. While the last few years have been solid, the revenue is project based and therefore, potentially volatile. The good news is that the company has just sold this business for $63 million in cash.

Secondly, beginning in FY17, the company’s software business began transitioning from perpetual licence sales to a subscription model. Like most businesses relying on the sale of perpetual licences, revenues were lumpy, with growth depending on generating more new wins each year.

In contrast, the subscription model has seen consistent year-on-year growth since launching in FY17. While insignificant at first, it’s now the largest portion of their revenue, meaning revenue is far more recurring in nature, than it used to be. – as shown in the chart below.

With the advisory business gone, we’ve got a high-growth SaaS business that earned around $46 million in subscription revenue last year, plus another ~$25 million in maintenance and consulting fees.

It’s also got an on-market buyback that can buy back up to ~15% of issued capital. The company has also stated that the $63 million in proceeds from the sale of the advisory business is intended to be returned to shareholders as a capital return (pending ATO ruling).

There are some challenges, though. The software business’ revenues are heavily weighted to H2, which, while it isn’t problematic in itself, does make things tricky when combined with the company’s recent guidance – or lack thereof.

At the H1 FY2025 update in February, the company pulled its guidance and didn’t issue new guidance, pointing to changes in corporate expenditures, costs and revenues associated with the sale of the advisory division.. While this was totally fair and understandable given the sale of roughly half of their business, it makes it very difficult to provide any reasonable estimate of near-term earnings.

The current market cap is around $620 million at a share price of $2.79.If you assume that shareholders will receive at least $60m in capital return in short order, you could think of it as paying about $560m for the business.

The prize asset is the sticky recurring revenue from software subscriptions, of which the company generated about $50m in the last twelve months. Therefore, you could think of the current price as paying around 11x recurring revenue for a software business growing at between 10% and 20% per annum.

I don’t love valuing companies on revenue multiples, but in this case, even for a growing SaaS business, the current multiple feels a little on the pricey side to me. While it sits in the too-hard basket for me, the improving quality of the business has me keen to follow along with A Rich Life’s regular RPM Global stock analysis.

Key stats:

• Market capitalisation – ~$620 million
• H1 FY2025 net profit (NPAT) – $4.7 million
• Growth in share count (last 3 FYs) – 0.9% p.a.

Note: RPMGlobal’s cashflows are heavily weighted to the second half of each financial year, so looking at H1 FY 2025 in isolation will give you the wrong idea. If you look at the full year, the company is free cash flow positive.

So after going through this screening exercise, I think we’re left with:

1. A capital intensive, cyclical business, but with growth tailwinds and an attractive valuation. I wouldn’t want to load up my portfolio too heavily with companies like this, nor would I consider it a long-term hold. But given the price, and the point in the cycle, I’d be comfortable owning it.
2. A company with a checkered past, but which seems to have reached an attractive point in its journey. Owning growing software businesses as they reach profitability is generally not a bad approach.
3. A very interesting niche SaaS business that is difficult to evaluate at this point in time. I’ll be marking this one to revisit post FY25 results.

All in all, I’d call that a successful day at the office.

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Disclosure: The author of this article does not own shares in any of the companies discussed and will not trade shares for at least 2 days following the publication of this article. The editor of this article, Claude Walker, owns shares in RUL, and will not trade shares for at least 2 days following the publication of this article. This article is not intended to form the basis of an investment decision and is not a recommendation. Any statements that are advice under the law are general advice only. The author has not considered your investment objectives or personal situation. Any advice is authorised by Claude Walker (AR 1297632), Authorised Representative of Ethical Investment Advisers Pty Ltd (ABN 26108175819) (AFSL 343937).

References:

1. Peak Diversification: How Many Stocks Best Diversify an Equity Portfolio? By Aidan Eccles, Lindsey Coffey and Derek Horstmeyer. Published by The Enterprising Investor (CFA Institute).
2. Kinatico Webinar H1 FY 25 Presentation, page 9.