There's little doubt that the medical device market is rapidly growing, with the iShares Dow Jones U.S. Medical Device ETF (NYSE: IHI) trading up over 20% this year. With components like Medtronic Inc. (NYSE: MDT) trading up over 30% and Thermo Fisher Scientific Inc. (NYSE: TMO) trading up more than 40% year to date, the medical device ETF's performance doesn't come as a surprise to many investors in the space that have been profiting handsomely.
But, investors looking for even higher returns may want to look into small- and micro-cap equities capable of generating significantly greater upside. AmbiCom Holdings Inc. (OTC Markets: ABHI) is a small $1.5 million micro-cap supplier of wireless technologies to the medical device industry. With profitable operations and rapidly growing revenues, investors willing to assume a little risk for greater upside potential may want to take a closer look at the stock.
Profitability Reduces Risk
The primary risk associated with many micro-cap stocks - defined as having market capitalization of less than $300 million - is bankruptcy. Many companies report rapidly growing revenues and even net profits, but operating and free cash flow tells the real story of how well companies are performing. And in many cases, rapidly growing companies can end up going bankrupt or getting into ill-fated financings due to their inadequate cash reserves.
Fortunately, AmbiCom has transitioned to profitability this year, generating net income of $387,540 during the nine months ended April 30, 2013. Moreover, the company reported net operating cash flow of $494,047 and net increase in cash and cash equivalents of $438,974, showing that the profitability is tangible. These metrics eliminate many "going concerns" and help provide a stable base from which it can grow long-term shareholder value.
Rapidly Growing Revenues
During the quarter ended April 30, 2013, AmbiCom reported revenues that increased 53% due to higher demand from customers for its newly introduced wireless cards. The company expects revenues from these products to continue to rise, while its new SDIO product and upcoming solar toothbrush technology could drive incremental increases. In addition to this organic growth, management now has the flexibility to pursue acquisitions to enhance its results.
It's also worth noting that high margins and stability of these revenues, afforded by the company's medical device end markets. During the same quarter, gross profits increased 30% and gross margins came in at a healthy 55.3%. Medical device end markets are also unique in that, once the U.S. FDA approves a medical device, it becomes very difficult for the components used within them to change, providing a lot of stability and recurring revenue to suppliers.
Potentially Undervalued Stock
AmbiCom trades at a significant discount to its peers and the S&P 500 benchmark, judging by a variety of different metrics. According to data from Morningstar, the company's 8.4x price-earnings ratio is sharply lower than the industry's 22.4x and the S&P 500's 17.0x ratios, suggesting that the market isn't fully appreciative of its growth. In fact, the firm's 50%+ top-line growth rates could well warrant a higher than average price-earnings valuation.
Figure 1 - Valuation Comparison - Source: Morningstar
The discount to its peers and benchmark indices is likely due to its small market capitalization and trading on the OTC Markets. In fact, many institutional investors are unable to purchase equities below certain thresholds. But with its growing revenues and profitability, management will likely pursue an uplisting to the NASDAQ or NYSE MKT in the future that could rapidly unlock this value, while individual investors can acquire stock on the cheap in the meantime.
AmbiCom represents an attractive investment opportunity for several reasons, including its profitability, growing revenues, and cheap valuation. Profitable operations help reduce the risks typically seen in micro-cap stocks, cheap valuation makes it desirable to investors right now, and growing revenues helps ensure that the valuation discount is eventually closed. While the process may take a few quarters, investors could be handsomely rewarded for their patience.
For more information about AmbiCom, see the following resources:
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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