The beauty of this approach is that if you’re willing to do your own research, you have a real chance of uncovering some genuine bargains. Today I’m going to look at two profitable small-cap stocks to see if either deserves a buy rating.

Watching the profits

With a market cap of about £35m, AIM-listed Synectics (LSE: SNX) is too small for most funds. This 30 year-old firm specialises in advanced surveillance and security systems. Key customers include oil and gas companies, casinos, transport operators and public authorities.

Today’s full-year results show that revenue fell by £0.8m to £70.1m during the year to 30 November. However, despite flat sales, adjusted pre-tax profit rose by 15% to £3m. Underlying earnings rose by 22% to 15.2p per share.

Stronger cash generation helped to lift the group’s net cash balance from £2.2m to £3.8m at the end of the year, enabling the board to raise the final dividend by 50% to 3p per share. This gives a total payout of 4p per share for the year, equivalent to a yield of about 2.1% at current levels.

Should we be betting excited?

Synectics business is quite lumpy, depending on periodic big orders. These can boost earnings in one year and depress them in the next.

According to management, gaming profits are likely to slow this year, while those from transport could rise. Oil and gas is expected to remain depressed for another year. Overall, the board expects profits to be broadly flat in 2018.

The share price has fallen by 10% today on this downbeat outlook. This has left the stock trading on a forecast P/E of about 13, with a prospective yield of about 3%. In my view this looks like a decent company, but I would prefer to wait for a sharper sell-off before considering an investment.

Faster growth elsewhere?

If you’re looking for a stock with a stronger track record of growth, one alternative might be CML Microsystems (LSE: CML). This Essex-based semiconductor firm produces two main lines of products, solid state storage and radio frequency communications chips.

Both product lines cater for growth sectors of the market, which helps to protect profit margins. Spending on research and development is consistently high, supporting future growth.

A strong recovery

After hitting some stumbling blocks in 2014/15, CML has returned strongly to sales growth. Sales rose from £22.8m to £27.7m last year and are expected to climb by around 15% during the current year.

The picture is less clear when it comes to profit growth. Analysts’ consensus forecasts for the current year suggest earnings of about 23p per share, broadly in line with 2016/17. This puts the stock on a forecast P/E of 23, with a prospective yield of 1.6%.

In my opinion, this could be an attractive growth stock with good long-term potential. CML’s balance sheet is strong and the group’s 15% operating margin is attractive.

On the other hand, I think the current valuation is quite demanding when compared to earnings growth. This is a stock I’d be more tempted to buy during a market correction.

The security and surveillance specialist advised that revenues rose 5% higher during December-May, to £33.7m, a result that powered pre-tax profit to £1.3m from £0.2m a year earlier. This prompted the company to affirm its expectations for the full year ending November 2017.

Synectics advised that it has clocked up new orders worth £41.8m in the first half, up from £38.4m in the corresponding period last year. And this powered the company’s order book to £33.7m, up 28% from the end of fiscal 2016.

This stellar performance has encouraged the AIM business to shell out a 1p per share interim dividend, the first midway payment for four years.

A pretty picture

And Synectics has painted a promising picture looking ahead, commenting that “the market for high-end electronic security and surveillance worldwide is fundamentally strong and likely to remain so.”

While the company cited current economic and political uncertainty as a reason for caution, it added that “the state of Synectics’ current contracts and order book give us confidence that the Group’s prospects for the remainder of this financial year and beyond are good.”

The City expects it to keep making tracks and expects earnings at the Warwickshire business to rev higher in the coming years — rises of 10% and 33% are pencilled in for this year and next.

I reckon a subsequent forward P/E ratio of 16.2 times is decent value given Synectics’ ample growth opportunities as the emphasis on surveillance grows. And the AIM play also offers plenty of reward to dividend chasers, at least if broker projections are to be believed.

A 4p per share payout is forecast for fiscal 2017, up from 2p last year and yielding 1.8%. And the yield leaps to 2.6% for next year thanks to predictions of a 6p dividend.

Food favourite

Greencore (LSE: GNC) is another stock expected to remain a hit for growth hunters.

Sure, earnings expansion is expected to slow to a trickle in the current fiscal year ending September 2017. But the bottom line is anticipated to crank back into life from next year thanks to a bright outlook in its UK and US marketplaces, helped by recent acquisitions and the massive investment it has made in its manufacturing and distribution capabilities. An 11% profits rise is currently anticipated for 2018.

This results in a very attractive prospective P/E multiple of 13.3 times. And the food manufacturer also provides plenty of potential for income chasers.

Greencore’s dividend of 5.47p per share last year is expected to leap to 5.9p in fiscal 2017, resulting in a 2.5% yield. And a further dividend hike is predicted for next year, an estimated 6.4p reward driving the yield to 2.8%.

I reckon Greencore could prove a very lucrative share selection in the years ahead.

Improving outlook

The recent half-year results from Colefax (LSE: CFX) showed that the company is experiencing challenging trading conditions. The international designer and distributor of furnishing fabrics and wallpapers recorded a decline in its earnings which is expected to lead to a fall in its bottom line of 39% in the current year. Much of this is due to the challenging trading conditions experienced in its core US market, while the hedging of the US dollar proved to be a disappointing decision.

However, an investment in the business via significant one-off capex this year should provide a boost to the company’s performance. Its new US showrooms and new Decorating Division premises in London may also positively catalyse its financial performance. As such, the company is expected to record a rise in its earnings of 20% in the next financial year. This is due to be followed by further growth of 12% the year after.

With Colefax trading on a price-to-earnings growth (PEG) ratio of 1.5, it seems to offer a sufficiently wide margin of safety to merit investment. Although its shares could remain volatile and its earnings outlook may deteriorate depending on its operating environment, the risk/reward ratio on offer appears to be favourable.

Solid growth

The recent results from advanced surveillance technology solutions provider Synectics (LSE: SNX) showed that its strategy appears to be working well. It was able to increase revenue by 4% and underlying profit by over 80% in the most recent financial year. Much of this was due to the actions it has taken to improve its business model and invest for the future. It now has a strong position in a variety of sectors and seems to be well-positioned to deliver high growth in future.

Looking ahead, Synectics is forecast to record a rise in its bottom line of 10% this year and 33% next year. This puts it on a PEG ratio of just 0.3, which indicates that it offers high growth at a reasonable price. As well as this growth potential, the company is also expected to yield 2.6% next year from a dividend which is due to be covered three times by profit. This suggests a rapidly-rising dividend could be on the horizon, which further enhances the attraction of the company’s shares.

Certainly, neither Synectics nor Colefax are risk-free. Both stocks are relatively small and could experience disappointments over the medium term. However, with wide margins of safety, they may be worthy of a closer look.