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When things go wrong with growth stocks, the results can be dramatic. High price-to-earnings (P/E) ratios can make share prices fall sharply if profits don’t come in as expected.
In these situations, the investor’s job is to figure out whether the issues are short-term or more durable. And in at least one such case, I think the long-term outlook’s still very positive.
Small-cap tech
In general, the UK isn’t known for its tech stocks. But outside the FTSE 100 and the FTSE 250, there are some interesting small-cap shares I think look very interesting.
One of these is Celebrus Technologies (LSE:CLBS). It’s a software company with a product that allows companies to see what their customers are doing on their website or app in real time.
Unlike other systems, it doesn’t rely on cookies, which makes it more difficult to opt out of. And the firm’s proprietary technology is patented, creating a high barrier to entry.
The balance sheet is also strong, with around £23m in cash (which is a lot for a company with a market value of £68m). But the stock fell 20% in a day after its latest trading update.
What’s going wrong?
The latest report from Celebrus indicates that revenues are set to go from $40.9m (the company reports in dollars) in 2024 to $38.6m this year. In other words, sales are set to decline.
Pre-tax profits are expected to be higher (to $8.7m from $7.6m) but falling revenues are not what an investor might expect from a growth stock. And that’s the biggest issue.
Celebrus put this down to geopolitical uncertainty. I think this is plausible, but it highlights a risk investors need to keep in mind both now and over the long term.
In other words, it’s not just consumers that are under pressure. Businesses are having to be careful and this is making them think twice about investing in potentially useful software.
How big’s the problem?
Celebrus also announced changes to the way it defines and recognises annual recurring revenue (ARR). This is a key metric for investors looking to assess software companies.
Essentially, the firm intends to limit the metric to its own products rather than those it sells on behalf of third parties. On this basis, ARR increased 13.9% to $18.8m (£14.15m).
Growth in that high-margin revenue is set to take pre-tax profits up 14% to $8.7m (£6.55m). In the context of a stock with a market value of £68m, that’s a lot.
Despite the disappointing outlook, I think this is enough to justify the share price by itself and that’s before factoring in the £23m on the balance sheet. In my view, the stock’s undervalued.
I’m buying
Investors need to be mindful of the fact that businesses – like people – go through times when they have to pull in their spending. And this why the outlook for Celebrus is disappointing.
I suspect the decline’s temporary, but the current valuation looks attractive to me even based on the reduced numbers. As a result, I’ve been adding to my investment in the company.
