There is little doubt that our world will become increasingly digitalized, creating a long-term tailwind for some businesses in the technology space. Nonetheless, widely recognized business opportunities tend to attract fierce competition, dampening everyone's returns. Meanwhile, those mega-caps who leverage size and scale advantages to defend their market leadership may have to deal with the disadvantage of slowing growth.
We at Urbem looked into the small- and mid-cap group and were drawn to three names that have achieved the balance of a double-digit return on capital and a double-digit growth rate. All three companies are listed in the UK (though this is just coincidence).
While employing different business models, these companies all capitalize on the megatrend of digitalization, have compounded shareholder value over time and have high potential to continue delivering returns to shareholders over the foreseeable future. On the downside, all three companies only went puclic within the past ten years. Everything else being equal, a proven track record spanning less than a full economic cycle may bother some risk-averse investors, as these companies are untested in bear markets.
Softcat
Softcat (LSE:SCT, Financial) is one of the UK's leading resellers of comprehensive IT infrastructure offerings, with the mission to help customers use technology to succeed. Simply put, the company helps commercial and public sector organizations to identify the right digital infrastructure solution for their needs from over 200 vendors, procures it for them, implements that infrastructure and delivers a range of ongoing support and managed services.
So far, all sales have been domestic. Software, hardware and services account for 48%, 43% and 9% of the total revenue, respectively. The management believes it operates in a a large, growing and fragmented market.
Over the last five years, Softcat earned an average 18.3% return on assets and grew its operating income by a compouned annual growth rate (CAGR) of 18.9%. The company plans on expanding scale and capabilities as well as investing in people and skills to fuel growth for the long run. Some key market opportunities lie in the favorable trends in the areas of cloud computing, cybersecurity, data management and hybrid infrastructure.
Kainos Group
Northern Ireland-based Kainos Group PLC (LSE:KNOS, Financial) provides information technology, consulting and software solutions for businesses and organizations, particularly in the public, healthcare and financial services sectors. The company was founded as a joint venture between Fujitsu and The Queen's University of Belfast and became one of Northern Ireland's first campus companies. The company's first government project, the "Register to Vote" platform back in 2012, is now available to 46 million UK citizens.
The services at Kainos include customized digital solutions (primarily for government departments and agencies), Workday implantation and digital platforms in the mobile healthcare and automated testing arenas. Over 80% of the sales come from the UK and more than 90% come from existing customers, demonstrating robust client relationships.
For the last five years, Kainos earned an average 24.8% return on assets and grew its operating income by a CAGR of 24.5%. Moving forward, the company seems to rely on investments in research and development, cross-selling and regional expansion to drive organic growth. The management believes that growth prospects remain "very strong."
FDM Group
UK-based FDM (LSE:FDM, Financial) is the market leader in the "Recruit, Train and Deploy" industry, which is engaged in providing professional services in information technology. The principal business model involves recruiting mostly university graduates, returners to work and ex-military personnel, who are then trained and placed with clients across a number of sectors. One of the company's purposes is to "fill clients' digital skills gaps." Service offerings range across various disciplines, including development, testing, business analysis, cybersecurity, data services and business intelligence.
FDM operates through its dedicated training centers and sales operations in major cities globally. As of fiscal 2019, the UK and the Republic of Ireland represented nearly 50% of the total revenue, followed by North America (35%), APAC (8%) and EMEA (6%). Financial institutions account for the most considerable portion of the company's customer base. Major clients include large global banks such as Bank of America (BAC).
Over the last five years, FDM Group earned an average 35.8% return on assets and grew its operating income by a CAGR of 16.4%. To support the sustainable growth in shareholder value, the company plans on continuously attracting talents, investing in its training capacity, diversifying the client base and expanding the geographic footprint.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.
Read more here:
- Coloplast A/S: A Quality Growth Story
- Buffettology's Three Categories of Moats
- Team17: Another British Entrepreneurial Story in a Niche Space
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