However, decent growth rarely goes unrecognised by the market. So, valuations tend to be higher for companies with good earnings prospects. But a company’s valuation can be viewed as a mark of quality. And I’d expect to pay more for a business growing its earnings by 50% a year than I’d pay for one growing at 20%.

Software for businesses

One recent purchase I’ve made is Cerillion (LSE: CER). The company provides billing, charging, and customer relationship management software solutions for several industries. Its client sectors include telecommunications, finance, utilities, and transportation. 

In May, the company posted a robust set of half-year results. And chief executive Louis Hall said the directors see “excellent opportunities for continuing growth and [that] the new customer sales pipeline has grown significantly”.

City analysts expect earnings to grow by around 30% in the current trading year to September 2022 and by about 19% the following year. But with the share price near 1,059p, the forward-looking earnings multiple is running at just over 31 for 2023. That’s not cheap and the valuation adds a layer of extra risk for investors. 

But I’m hopeful Cerillion can keep up its operational momentum for years to come. And a recent major contract win announced in July encourages me to believe the signs are good.

Focused on US healthcare

I’m also holding Craneware (LSE: CRW). The UK-based company develops licensing and ongoing support of computer software for the US healthcare industry. 

The company released a strong trading update last week. And chief executive Keith Neilson said he’s looking forward to the future “with confidence”.  

Just over a year ago, Craneware acquired a company called Sentry. The addition increased scale and offering of the business. Neilson said around 40% of all US hospitals now use Cranware’s services.

Meanwhile, City analysts predict growth in earnings of just over 9% in the current trading year to June 2023. And with the share price near 1,730p, the forward-looking price-to-earnings rating is around 22. Not cheap. But I reckon Craneware could be developing some decent operational momentum. Time will tell. But this investment is not without risks.

Payment solutions

Another recent purchase was Equals (LSE: EQLS). It’s a UK-based fintech payments company. It provides small and medium-sized enterprises with a suite of payments products, such as foreign exchange transactions, prepaid card solutions, faster payments, and accounts for receipts and payments. 

In July, the company released a trading update trumpeting “84% growth in revenue and continued strong product uptake”. And chief executive Ian Strafford-Taylor said he believes revenues are “highly inflation-resistant“.

Meanwhile, City analysts predict a meaningful return to positive earnings in 2022 followed by an almost 35% uplift in 2023. Of course, any company can miss its estimates. And one risk is that the business operates in a competitive sector.

However, with the share price near 99p, the forward-looking earnings multiple is around 16 for 2023. And I think that valuation looks fair.

Although there is no guarantee of success, my plan is to hold all three of these stocks for years as the underlying growth stories play out.

A tech stock with recurring revenue

Craneware (LSE:CRW) is a software-as-a-service (SaaS) business that collaborates with US hospitals and other healthcare providers. Using its platform clients can quickly identify the true underlying costs of treating specific patients. Simultaneously, it also exposes any inefficiencies that once removed, lead to margin improvement.

As a result, hospitals can manage patient billings and expenses more effectively while also further mitigating any compliance risks.

The platform is a modular system that has 17 different solutions. Clients pay to access the modules they need through fixed contracts that typically span three to nine years. Needless to say, that’s quite a financial commitment, so it’s very reassuring to see that contract renewals are on the rise.

The fact that clients are willing to renew a contract for up to nine years indicates that the platform has become an essential tool, granting Craneware substantial pricing power. At least that’s what I think.

The risks of investing in AIM shares can be high

As previously stated, AIM shares are already exposed to a higher risk level than other listed stocks. And Craneware has the additional challenge of navigating one of the most highly regulated industries in the world – the healthcare sector.

The tech stock’s platform is still subject to patient care regulations as it is indirectly involved with health centres’ day-to-day operations. These restrictions do create barriers to entry for rival firms. But there are already other companies that offer similar services. Any breach could have a significant impact on the firm’s reputation that would undermine its strong pricing power and likely lead to client loss.

Another threat comes in the form of cyberattacks. The data being used on Craneware’s platform is especially sensitive (patient files, medical histories, insurance policies). Any breach in security that exposes personal data could also hurt its reputation and could lead to a rapid decline in contract renewals.

A cheap tech stock in hiding

The stock’s P/E ratio today is nearly 50. That’s hardly what I would call cheap. But a closer inspection reveals a different picture.

When a client pays upfront, Craneware doesn’t recognise the revenue in a single chunk. Instead, it is broken up and recorded over the length of the contract. The income statement for 2020 reported that total revenue was $71.5m. But there is an additional $200m that will be earned from existing clients, and new planned subscriptions over the next three years.

Source: Craneware Annual Report 2020 

With a net profit margin of 24%, if we include the additional $200m revenue, that would indicate a total profit for 2020 of $65m. At today’s price, this places the P/E ratio at 9. Now that looks like a cheap tech stock that I’d want in my own portfolio even with the added risk from AIM Shares. Especially since US healthcare spending is expected to reach $6trn by 2027. 

A less risky AIM stock

Bioventix (LSE: BVXP) is the first AIM stock that I particularly like. The biotechnology company is involved in the development and supply of antibodies. It has seen tremendous growth over the past few years, with earnings increasing from £1.6m in 2014 to £6.5m last year. Recent interim results saw pre-tax profits rise 31% over the six months to the end of December 2019.

The firm also pays a strong and healthy dividend. Thanks to a highly cash-generative model, it currently yields over 2%, and has been consistently growing. In fact, the interim dividend was recently raised by 20%, despite the poor economic climate. As such, I can see Bioventix become one of the big dividend payers of the future.

My only issue with this AIM stock is its pricy valuation. Although its price-to-earnings ratio of 32 is not overly expensive in comparison to other biotechnology companies, a price-to-book ratio of 22 is significantly higher than the market average of 1.3. Even so, quality stocks such as these are going to be more expensive. With no debt, an ever-growing dividend, and profit margins of nearly 70%, I believe it’s worth every penny.

A market leader in US healthcare

Craneware (LSE: CRW) provides software to US hospitals to help them manage patient billing and costs. There are many reasons why I like this AIM stock. Firstly, it has an extremely robust balance sheet. This includes no debt, cash reserves of nearly $50m and undrawn debt facilities of $50m. As a result, the company should be able to capitalise on any market opportunities that arise. I also like the fact that the CEO and founder of the company, Keith Neilson, is also the second-largest shareholder. This demonstrates strong commitment to the firm, and management is evidently experienced.

Once again, there are problems to underline. For example, the share price was punished in 2019 when growth temporarily stalled. As a result, Craneware shares are trading at a discount of over 50% from the all-time high. But with a large number of recurring revenues, and limited impacts from the pandemic, it looks set to gain back these losses in the coming years.

All in all, I’d buy both these AIM stocks. While the AIM market can often be risky and unpredictable, both these stocks seem safer options. With both paying decent dividends already, they could also become the income stocks of the future.

Of course, there are no guarantees when it comes to investing. Here, however, are three minnows that I suspect will have rewarded investors by the time they’re ready to swap the office for the beach.

Future ISA star

As I predicted almost two months ago, online instrument supplier Gear4music (LSE: G4M) released some cracking numbers this week. The business has benefitted hugely from the lockdown with more people than ever learning and practicing music to pass the time. 

Naturally, the share price has reacted positively to news that profits have exceeded management expectations. Whether this momentum will remain near-term is hard to say. The lifting of restrictions could mean earnings have peaked for a while. 

On the other hand, the likelihood that many independent retailers on the UK’s high street will find the going tough could play into the £90m-cap’s hands. Indeed, CEO Andrew Wass has said Gear4music is “confident of continued financial improvements during FY21.“

Regardless of what happens in the rest of 2020, I remain confident this stock could prove a real winner for long-term investors.

Move fast

Another small-cap stock that could reward patient ISA investors is software company Oxford Metrics (LSE: OMG).

Already operating in over 70 countries, Oxford assists firms in measuring and capturing motion. It does this via its infrastructure management-focused Yotta division or movement analysis Vicon business.

What I particularly like about this company is the diversity of its clients. These range from highways authorities needing help to manage road networks to film studios wanting support in creating visual effects. 

Perhaps unsurprisingly, Oxford’s share price hasn’t really recovered from March’s sell-off. It’s still 33% below the all-time high hit back in February.

While recent trading is unlikely to be good, I sense now might be an opportunity for ISA holders to acquire a slice of the business whose fundamentals have been steadily improving. The balance sheet also shows no signs of distress, boasting net cash of almost £11m.

Expensive…but worth it

Last on my list of small-cap opportunities is US-focused software firm Craneware (LSE: CRW). Its tech is designed to highlight operational and financial risks to hospital managers and how they can make things more efficient.

The thing to realise about Craneware is that its valuation has always been high. Despite the recent market crash, shares still trade on a forecast price-to-earnings (P/E) ratio of 31 for FY 21 (beginning in July).

Before dismissing the company, however, it’s worth mentioning that the five-year average P/E is 36. Moreover, Craneware has consistently shown why it deserves its premium rating. Margins and returns on capital are seriously high. It also dominates its niche and carries very little debt. This all piques my interest, even if the adoption of its new analytics platform is taking longer than expected. 

Craneware’s share price could remain under pressure if we get a second Covid wave/market crash. However, I’m having trouble finding reasons to see why it won’t reward ISA investors over the long term.

Reassuringly expensive?

AIM-listed Craneware (LSE: CRW)  develops and licenses computer software for the US healthcare industry that helps hospital managers identify operational and financial risks. It’s a superb company based on its consistently great returns on capital, fat margins, lack of debt and market-leading status.

Unfortunately, holders rushed to sell a couple of months ago after it revealed a big drop in sales that would prevent it from meeting its full-year expectations. The slowdown has been attributed to teething problems relating to Craneware’s new cloud-based analytics platform (Trisus Health Intelligence). 

Having fallen 37% since late June, Craneware now occupies a place on my watchlist. While tempted to buy given the recent price weakness, I’m content to wait for full-year numbers on 3 September before potentially opening a position. The shares still change hands on a lofty 34 times forecast earnings for FY20, after all.

Also reporting next month is a former holding of mine — videogame services provider Keywords Studios (LSE: KWS).

The recent explosion of interest from investors in all-things gaming-related has proven a huge boon for the Dublin-headquartered business with its value soaring 400% from September 2016 to August 2018. Since then, however, the direction of its share price has been less predictable.  

This isn’t to say that Keywords isn’t doing well. In its most recent update, the firm stated that H1 revenue was likely to be around 39% higher at just over €153m thanks to “particularly strong growth” at its Functional Testing and Game Development divisions. Indeed, trading has been so good that the company has been required to expand at a faster rate than expected, requiring additional investment (although this is likely to benefit margins in H2). Adjusted pre-tax profit should come in 15% higher than the previous year at roughly €18.4m.

Perhaps the biggest concern with Keywords is its growth-by-acquisition strategy. This is fine when everything goes smoothly but could come under scrutiny if the firm shows signs of struggling to integrate new parts of its business. For now, the company trades on a steep valuation of 31 times earnings, leaving little room for error. Interim results are out on 18 September.

A final stock that updates next month (interim results, 3 September) is semiconductor wafer producer IQE (LSE: IQE) — another former holding of mine that, regrettably, proved far less successful than Keywords. 

IQE’s stock is currently the most expensive of the bunch at an eye-watering 55 times earnings. That said, analysts are forecasting a treble-digit rise in earnings per share in FY20. If the mid-cap were to achieve this, it would reduce the valuation to 21 based on today’s share price. 

I think this is optimistic, particularly as IQE is currently suffering as a result of the ongoing trade war between Donald Trump and China. It’s already told investors that full-year revenue for 2019 will miss forecasts.

Perhaps unsurprising, IQE remains popular with short-sellers. Worryingly, only Kier Group, AA, Thomas Cook and Wood Group are attracting more attention. That’s not a club any company wants to be a member of.  

Taking all this into account, I’d argue that IQE is the most at risk of crashing in September.

Should long-term investors treat this as a buying opportunity, or is more bad news likely? Let’s take a look…

An emergency admission

Four months ago, Craneware — which makes billing software for US hospitals — reported “strong sales activity and opportunities” and “increasing market engagement.” Unfortunately, things seem to have gone downhill since then.

In Friday’s profit warning, the company admitted “the timing and quantity of sales” have been lower than expected during the second half of the year. As a result, sales are only expected to rise by 6% this year, compared to forecasts of 18%.

Profit growth will also be lower. Earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to rise by 10% for the full year.

What does this mean?

Today’s guidance seems to imply Craneware’s growth has come to a halt during the second half. Reading between the lines, I wonder if the firm’s new Trisus product is taking time to gather momentum.

My sums suggest second half revenue is likely to be about $35m — unchanged from the first half of the year. For a company that’s delivered strong growth every year since 2014, that’s a concern.

Before today’s news, CRW shares were trading on a steep 55 times 2019 forecast earnings. I now estimate this forward multiple at about 32.

Although I admire this firm’s high-profit margins and strong growth record, I think the shares continue to look fully priced. Personally, I’d want to look for an opportunity to buy below 1,800p. I’d await further news before making any trading decisions.

Construction delays

I view infrastructure group Costain as one of the best quality stocks in the construction sector. But today’s news shows the company is still prone to the classic problems for investors in this area — delayed contracts and legacy contract costs.

The firm says projects including the M6 Smart Motorway, Preston distributor road and HS2 Southern Section have been affected by delayed start dates. An upgrade to the M4 motorway at Newport was cancelled by the Welsh government earlier this month.

These setbacks mean underlying operating profit for the year is expected to fall by more than 20%, to between £38m and £42m.

In addition to this, the company will face a one-off £9.8m charge relating to remedial works on a contract that was completed in 2006. The sub-contractor that actually did the work has long since gone bust, leaving Costain carrying the can after all this time.

Profit slump

The latest broker note I’ve seen suggests today’s profit warning is likely to result in Costain’s adjusted earnings per share falling by about 30% in 2019, and by a similar amount in 2020. A matching dividend cut is also expected.

These forecasts price the stock on about eight time earnings, with a dividend yield of 5.7%. Given the uncertain outlook and the risk of a construction downturn, I think the shares look fully priced for now.

For long-term shareholders prepared to ride out the storm, I might hold onto the stock. But otherwise, I’d view this as a sell… until better news emerges.

One company that services this market is Craneware (LSE:CRW), a Scottish firm that sells billing software to the US healthcare industry to deliver savings for its clients. Its focus is on the largest and most competitive market in the world, which is a shrewd move as success in America gives it the best chance to carve an impressive international market share for its product. Its software is currently used by around a quarter of US hospitals so it has plenty of room to grow, and as my Foolish colleague Roland Head points out, once the products are used by hospitals it is very difficult to replace them. This helps growth as existing revenues are well protected.

Is the company overpriced?

It fits the profile that I look for in a stock, with very good return on capital employed (ROCE) of 36% and a good operating margin at 28%. These attributes make it a high quality stock and such companies normally trade at a premium. Craneware is no exception as the price-to-earnings ratio (P/E), stands at a hefty 42x. This still seems a bit rich considering a growth rate of around 15%, but is there another reason for the premium? Software companies can scale very quickly and I think a lot of market participants feel there could be a bumper set of half-year results on the way on March 5.

The trigger for the big re-rating in the share was the earlier full-year results (although it has now been dragged back by market conditions). These were good, but I think the main cause for excitement among investors was the news of a 100% increase in new sales, considering the company has an excellent retention rate, this could make for a very good year. The firm is also releasing a new product, Trisus, which it says has had positive results from early adopters. 

Backed by management

I like founder-run companies, especially where they have a lot of skin in the game, and on September 10, following the FY results, the CEO purchased £150k of stock to take his holding to 12.7%. This is a big show of confidence considering that the P/E ratio at the time was around 50, a level at which you may expect an insider to consider taking some profits.

Brexit-proof?

While I personally feel that Brexit problems should be resolved long term, one of the benefits of this business is that most of its revenues come from the US, therefore the company will benefit from any falls in the pound against the dollar. Nevertheless the share price has fallen recently showing how temperamental the stock market can be in uncertain times.

With this in mind I might wait for a bit more certainty in the markets before I think about buying Craneware, but this is an exciting stock that I’d be happy to own. 

In response, Boohoo rushed out a statement reporting record Black Friday sales. Management said that profits should be in line with existing City forecasts. But despite this reassurance, Boohoo’s share price is down by 20% so far this year.

If Boohoo can continue to outperform ASOS, then this could be a buying opportunity.

Is Boohoo better than ASOS?

Boohoo and ASOS seem similar at first glance, but there are some big differences. The first is that Boohoo only sells its own products. These are sold under three brands, Boohoo, PrettyLittleThing and Nasty Gal.

By focusing on own-brand sales, management has direct control over the style, price and quality of the products. It is also able to build a valued brand which customers seek out.

I think this is one reason why Boohoo is more profitable than ASOS. Boohoo generated an operating margin of 6.6% over the 12 months to 31 August. For ASOS, the equivalent figure was 4.2%. Now ASOS is warning that this margin will fall to 2% over the coming year.

My verdict

I’m convinced that Boohoo is a better business than ASOS. But is Boohoo a buy?

After recent falls, BOO shares trade on a 2018/19 forecast price/earnings ratio of 39. Earnings are expected to rise by 22% during the current year and by a similar amount in 2019/20.

This gives the stock a price/earnings growth ratio (PEG) of 2.2, according to my calculations. That’s well above the level of 1.2 often used by growth investors to find undervalued stocks.

For investors with a long-term view, Boohoo may still be worth considering. But in my view the shares still look quite fully priced. I’d rate Boohoo as a hold, but I think there are better options elsewhere.

A real buying opportunity?

One stock that’s come onto my radar after recent falls is software group Craneware (LSE: CRW).

This £575m company produces software used in US hospitals. Craneware says that its products help to maximise revenue, control costs and ensure compliance. It’s not hard to see how valuable this could be, given that most American hospitals are privately run.

The Craneware share price has fallen by 35% since mid-September, thanks to the widespread market sell-off. In reality, I think the share price had run ahead of itself at more than £35. But I’m more interested in the stock at its current level of around £22.50.

Very profitable

You see, this is an extremely profitable business. Not only are profit margins high, at about 28%, but Craneware’s customers are generally quite ‘sticky’. Once the firm’s systems are embedded into a hospital’s processes, it’s hard to change to another supplier.

The firm earns revenue through multi-year contracts to supply and support its software. This means that forward earnings are generally very predictable.

Earnings per share have grown by an average of 14% per year since 2014, and this rate of growth is expected to continue. The dividend yield is modest at just 1.3%, but the payout has grown by nearly 13% per year, providing attractive income growth.

As with Boohoo, Craneware shares look fully priced on 39 times forecast earnings. But in my view this is a much better quality business with more robust profits. I’d consider buying these shares at current levels.

In the five years to yesterday, the shares had climbed well over 450% to 2,290p. In comparison, the value of FTSE 100 has increased just 15%. Clearly, investing in the latter through an index tracker or exchange-traded fund would have been less risky thanks to capital being deployed across a large number of businesses rather than only one. Nevertheless, Craneware shows just how powerful an impact buying quality, small companies can have on your wealth.

Today’s results for the year to the end of June suggest this momentum could continue for some time yet. 

An “outstanding” year

Revenue increased 16% to $67.1m with five “significant contract wins or contract extensions” allowing the company to record a 100% increase in new sales over the year. Pre-tax profit moved 12% higher to $18.9m.

With numbers like these, it’s understandable if CEO Keith Neilson was in a bullish mood. According to him, Craneware’s “outstanding” last year is “by no means the end of the journey“. Possessing a huge quantity of healthcare-related data and a broad customer base, management now believes the company has the potential to “sit at the heart of the move to value-based economics“.

Thanks to a record sales pipeline and growing engagement with its new products (such as its Trisus cloud-based platform), it’s a struggle for market participants to argue against this — which explains why Craneware’s stock was up over 13% this morning.

To be clear, a seriously high valuation of 52 times earnings in the current year makes this a stock for only the most confident of growth investors. Encouraging as the 20% rise to the total dividend (to 24p per share) is, a predicted yield of just 1% for 2018/19 before today also means new owners will be nearly wholly-reliant on further share price gains.

Nevertheless, the importance of having reliable data should mean that Craneware’s products are unlikely to be ditched on a whim, giving the Edinburgh-based business the kind of revenue visibility that many businesses would kill for. This fact, combined with its strong financial position — $52.8m in cash at the end of June — mean that I remain a firm fan of the stock.

Even more profitable

While Craneware has been a winning investment, it still has some way to go to rival the success of carbonated mixer supplier Fevertree (LSE: FEVR).

Since listing on the market back in November 2014, the stock has moved from 165p to a quite remarkable 3,763p, highlighting how nimble, marketing-savvy new entrants can exploit a gap in an industry and achieve massive success in a relatively short amount of time.

For how long this kind of form can continue is anyone’s guess (I’ve already been very wrong on this stock). With a valuation of almost 79 times forecast earnings, there’s clearly little room for error. Should the company’s efforts to crack the US market not come off, there’s a chance the shares could fall sharply.

Not that this is putting investors off just yet. The fact that “significant institutional demand” led founders Charles Rolls and Tim Warrillow to sell 3,000,000 shares (or 2.6% of Fevertree) for 3,450p a pop back at the start of August is evidence of the company’s enduring popularity. This disposal was 50% more than originally intended. Since then, the stock is already up 9%.

“Explosion of demand”

It’s hard not to be impressed by the numbers. Chalking up its eighth consecutive year of growth, income at the mid-cap more than doubled to $341.2m, thanks to a 127% rise in income from cases. Net profit after tax jumped 130% to just under £265m while return on equity (how much profit Burford makes with each pound of shareholders’ equity) climbed to 37.4% compared to £21.1m in 2016.

Commenting on today’s figures, CEO Christopher Bogart reflected that the company had seen an “explosion of demand” for the company’s capital, resulting in new commitments of $1.34bn. Now boasting a “widely diversified portfolio“, Burford has $3.3bn invested (and available for investment) and $1.7bn in assets under management.

Looking ahead, 2018 looks like being another strong year. In sharp contrast to the minuscule $1m employed over the first two months of the previous year, the company has already committed $128.5m to 12 new investments so far. In addition to this, Burford revealed yesterday that it had sold its Teinver investment for $107m in cash — realising a $94.2m gain and a stonking 736% return on capital.

Clearly, any company performing as well as this is likely to become increasingly expensive for investors to acquire going forward. That said, I’d be tempted to wait for the inevitable period of profit-taking to pass before taking a position.

As a stock to buy and hold for the long term, however, Burford continues to look like a great option.

High riser

Another company that’s been over-achieving recently is £515m-cap Craneware (LSE: CRW).

Shares in the business — which produces software for the fast-evolving US healthcare market — have soared 63% over the last year alone. Interim results, released earlier this month, go some way to explaining why.

The bad news? It should come as no surprise that the cash-rich firm is looking fully valued right now, with stock changing hands for an eye-popping 49 times forecast earnings. As to be expected with high growth companies, there’s also little in the way of dividends, even if recent double-digit hikes are encouraging.

For these reasons, I’d be tempted to keep this company on my watchlist for now in the hope that another general market wobble may provide a better entry point.