One small-cap stock I am considering is XL Media (LSE:XLM). Is now a good time to buy the shares for my holdings?

Website producer

As a quick introduction, XL is a leading digital publishing business, responsible for operating over 2,000 websites. These websites publish content across a variety of industries including sport, betting, personal finance, and more.

So what’s happening with the XL share price currently? As I write, the shares are trading for 29p. At this time last year, the stock was trading for 55p, which is a 47% decline over a 12-month period.

To buy or not to buy

As a penny stock, XL is more susceptible to risks than larger, more established businesses. Nevertheless, I will look at the pros and cons of adding the shares to my holdings.

FOR: XL’s performance recently is a positive for me, although I am aware that past performance is not a guarantee of the future. Last month, XL reported that for the year ending 31 December 2021, revenue, operating profit, EBITDA, and cash generation were all up compared to 2020. This was primarily due to the market for advertising and marketing returning to normal levels after the pandemic. Although the pandemic isn’t fully behind us, the future could be fruitful if XL can continue its recent trading momentum.

AGAINST: Current macroeconomic headwinds such as inflation could have a detrimental impact on performance for XL. With inflation soaring, there is a chance that businesses could cut costs and marketing and advertising departmental budgets could come under pressure. This is a tangible risk for many FTSE stocks.

FOR: I like the look of XL’s business model. It has a vast profile and presence with operations throughout the world. It supplements this with regular acquisitions that can boost its offering and profile. In turn, this can boost performance and shareholder returns too. I also noted that CEO Stuart Simms purchased shares last month. I am buoyed when insiders buy shares, as they are the best placed to know if a firm is on the track to success. If the CEO is willing to buy shares with his own cash, this may be an indicator that perhaps I should too.

AGAINST: Although XL has an appetite and history of acquisitions, there is always the risk of one not working out. Two primary reasons are a lack of synergy between the two businesses and overpaying for a business. These can often lead to messy and expensive separations if, for example, XL had to dispose of a business that did not amalgamate well into its offering.

A FTSE stock I would buy

Looking at other factors, XL Media shares look decent value for money currently on a price-to-earnings ratio of just 14.

Furthermore, the advertising and marketing world is bouncing back from a lull in activity due to the pandemic. These activity levels are expected to continue on an upward trajectory. The positives outweigh the negatives for me. Due to this, I would be willing to add a small number of XL shares to my holdings.

Of course, a fresh economic downturn could throw such bright forecasts off track (industry experts the Advertising Association and WARC think global advertising expenditure will rise 7.7% next year). This could be caused by a worsening Covid-19 crisis or soaring inflation, for example.

Still, it’s my belief that this threat is baked into XLMedia’s rock-bottom valuation. City analysts think earnings here will soar 152% year-on-year in 2022. This leaves the company trading on a forward price-to-earnings growth (PEG) ratio of 0.1. Any reading below 1 suggests a stock could be undervalued by the market.

Huge restructuring

Besides, I think that XLMedia’s ongoing transformation programme provides plenty to get excited about. The business — which supplies digital marketing data and operates sports, gambling and personal finance websites — is taking steps such as overhauling its data infrastructure. It’s also reshaping its global footprint to boost business and reduce costs.

Finally, I’m also encouraged by XLMedia’s commitment to growth through acquisitions. That’s even though, in theory at least, M&A action can leave a business exposed to risks like disappointing synergies and overpayment for an asset.

In late September, XLMedia snapped up BlueClaw Media for £1.8m to boost its European sports business. And it has plenty of cash on the balance sheet to continue growing its operations. I’d buy.

Take to the skies

Air Partner (LSE: AIR) is another penny stock I think could be too cheap to miss. The business trades on a forward price-to-earnings (P/E) ratio of 11 times. It’s a reading I don’t think reflects its excellent profits opportunities as private jet usage steadily grows. Oh, and this particular penny stock offers a meaty 3% dividend yield too.

Air Partner is primarily known for providing private jet chartering services. This looks likely to be a fast-growing market through to 2030 too. According to Argus Media, “demand for private business jet travel is expected to grow over the next decade as wealthier travellers migrate to more exclusive modes of travel.”

Changing traveller habits following the Covid-19 crisis are likely to give private jet usage a shot in the arm as well.

A penny stock that’s expanding for growth

I don’t think Air Partner’s just a great play on this industry however. The business has also built up a position in other aviation areas like security and safety through acquisition activity. These provide the business with extra strength through diversity as well as exposure to other potentially-lucrative areas.

Air Partner would suffer in the more immediate future if Covid-19-related travel restrictions are severely tighten. But all things considered, I think the potential rewards it could enjoy over the long haul make it a top penny stock for me to buy today.

Healthcare hero

Today, Venture Life Group (LSE: VLG) shares go for 68p a pop. It’s a penny stock I think could make me a lot of money as its transformation strategy clicks through the gears. Venture Life manufactures non-prescription healthcare products such as Dentyl mouthwashes, Procto-eze Plus haemorrhoid creams and Myco Clear fungal nail treatments.

Acquisitions are a key part of the UK share’s growth strategy and last January it made the transformative takeover of PharmaSource BV to boost its product ranges as well as worldwide distribution.

Venture Life has also invested heavily to increase production at its Biokosmes facility in Northern Italy. Capacity here now stands at 250,000 units versus 130,000 previously.

Encouragingly, the UK healthcare share has plenty of financial clout to keep investing in the business and pursuing its M&A agenda. Indeed, a £36m share placing at the end of last year gave it the strength to acquire women’s health and diabetes product specialist BBI in June and a series of oncology support products from Helsinn Healthcare earlier this month.

I’m confident this stock’s aggressive approach to acquisitions could light a fire under long-term profits growth. But remember that an M&A-led growth strategy can be extremely risky. Meanwhile, problems like unexpected costs, underwhelming revenues, and paying over the odds for an asset can be common problems that ultimately damage shareholder returns.

A penny stock that’s too cheap to miss?

XLMedia (LSE: XLM) is another UK penny stock I’m looking closely at for my ISA today. This 58p share operates thousands of websites covering the fields of gambling, sports betting and (more recently) personal finance. And it provides digital marketing services and data to companies in these arenas. All three sectors are growing quickly and this provides plenty of opportunity for the company to exploit.

I also like this UK share because it offers excellent value for money at its current price. City analysts think annual earnings here will rocket more than 600% in 2021. This leaves the company trading on a forward price-to-earnings growth (PEG) ratio of 0.1. A reminder that any reading below 1 suggests a company could be undervalued by the market.

XLMedia is speeding up restructuring efforts in a bid to better address its vertical markets and create a more agile machine. It’s a drive that’s expected to bring down costs by reducing the global workforce by around 15% too.

Now this stock operates in markets which are subject to intense regulatory scrutiny. And this has the potential to take a bite out of earnings if the legal landscape changes. Still, in my opinion, this risk is more than reflected in XLMedia’s ultra-cheap valuation.  

As a long-term investor, though, I’m not put off by the prospect of fresh choppiness. If I buy quality stocks, regardless of whether or not they trade below £1, I think they should still surge in price over a long time horizon. Here are two penny stocks I’d happily buy in June.

A low-cost penny stock with BIG dividends

In recent days I wrote about FTSE 100 share WPP and explained how marketing spending is steadily picking up momentum. Businesses are spending shedloads on advertising to attract customers following the shockwave of Covid-19. But it’s not just the ad agencies that are benefitting from this upswing, of course.

Take penny stock XLMedia (LSE: XLM) for instance. This UK share owns and operates around 2,000 websites and provides digital marketing data spanning the betting and sports industries. It is therefore well placed to ride the broader pick-up in advertising activity. And what’s more, the company is expanding its presence in the US to turbocharge revenues growth.

Today XL Media trades at 46.3p per share. This leaves it trading on a mega-low forward price-to-earnings (P/E) ratio of below 11 times. The company faces significant indirect risks from the gambling regulatory landscape as many of its clients are online betting companies. But I think its low cost, and its inflation-mashing 5.1% dividend yield, still make it a great buy today.

Putting the pedal to the metal

I think Pendragon (LSE: PDG) is another UK penny stock that also offers considerable value for money. At 18.5p per share the car retailer trades on a forward P/E ratio of 12 times. Firms involved in the sale and manufacture of cars tend to bounce back strongly in the early part of the new economic cycle. This is because demand for autos is one of the quickest areas of retail to recover when consumer confidence improves.

It’s a phenomenon that is already being borne out in Pendragon’s trading performances of late. Its newest update last month showed like-for-like operating profit swing 69% higher in the three months to March. Freshest data from the Society of Motor Manufacturers and Traders (or SMMT) shows that broader car sales in Britain have kept soaring since then too.

The SMMT said that 141,583 cars rolled out of UK showrooms last month. That was around 33 times higher than the number of sold vehicles in April 2020. And the robust result prompted the body to upgrade its full-year growth forecasts to 14%. Of course this penny stock’s recovery could stutter if the recent rise in Covid-19 cases continues and its showrooms are closed down again. But I still think its cheap share price still makes Pendragon an attractive UK share for me to buy in June.

The firm operates as a provider of digital performance marketing services to the gambling and gaming industry. And with the share price close to 62p, the forward-looking earnings multiple for 2020 is just below six and the anticipated dividend yield is above 8%.

Meanwhile, the return on capital has been running near 19% and the operating margin at about 37%. All those figures look tasty and make the enterprise appear to be a quality operation selling at a low valuation. But there’s a problem.

A challenged business

Indeed, revenue, cash flow, earnings and dividend payments have been volatile, and the share price has fallen back around 70% in just under two years. As I write, the shares seem to be continuing their descent, so it doesn’t look like Monday’s half-year results report helped much.

In the first six months of the year, revenue declined by almost 10% compared to the equivalent period last year and profit before tax plunged by nearly 22%. The outcome mirrors last year’s interim results, which featured similar declines. But on the bright side, earnings per share came in flat compared to last year, and the directors increased the interim dividend by just over 5%, “maintaining the group’s progressive dividend policy.”

The report claims the firm has a “strong” balance sheet with $43.1m of cash and short-term investments on 30 June. However, in last year’s interim report, the company had $51.3m of cash and short-term investments, so some of the money it did have has gone. But in fairness, the company has spent some of it buying back its own shares over the 12-month period. Meanwhile, borrowings and lease liabilities offset the current cash position by about $15m. However, the balance sheet does look sturdy.

Trying to diversify

The firm is in a state of flux and is trying to diversify its operations, such as with the fast-growing personal finance division, which represents 14% of the revenue reported, up from 7% of the total a year ago. But “industry-wide regulatory headwinds” are taking their toll on trading with the “key” Swedish, German, UK and Swiss markets “creating near-term challenges.”

Trading in July and August, after the period end, has been weaker than the directors expected and on top of that, acquisition activity has slowed down. So, they’ve revised revenue expectations down to $80m for the full year and estimate that Earnings Before Interest, Tax, Depreciation and Amortisation will be around $34m.

Despite its tempting-looking metrics, XL Media is actually struggling and shrinking in a challenged sector. It’s trying hard to diversify, but there’s no telling how long it will take for the firm to return to growth. Meanwhile, the shares could have much further to slip. We don’t know for sure, and that’s why I’m avoiding the stock for the time being.

Both companies are in the process of repositioning and restructuring their businesses. In this article, I will discuss the outlook for their earnings and dividends, and give my view on whether they have investment appeal at their current valuations.

Litany of issues

XLMedia’s publishing and media operations are largely linked to gambling. In September, when I wrote about its half-year results, there was a staggering litany of issues that had impacted performance. Many of these were related to regulation, but others included attacks on its websites and technical problems.

The share price was 103p at the time, and I didn’t think the valuation of 10 times forecast earnings was cheap enough, due to the multiple issues and uncertainties. Today, the price is 59p, as I’m writing (up over 5% on the day), following this morning’s full-year results release.

The company posted a 9% fall in adjusted earnings per share (EPS) to $0.13 (9.85p at current exchange rates), which means the shares are now trading at just six times earnings. The board reduced the dividend in line with the fall in EPS. Nevertheless, the payout of $0.7 (5.3p) gives a whopping yield of 9%.

On surer ground

Many of the issues the company reported at the half-year stage have receded. It’s also well into a radical business shift to cease low-margin media activities, and concentrate on growing its higher-margin publishing division. The focus is on regulated markets across the gambling sector, and a promising nascent personal finance business.

The company appears to me to be on surer ground now. And with the prospect of higher-quality sustainable earnings growth, and over $40m cash on the balance sheet, the dividend also looks pretty secure to my eye. I think the stock is now cheap enough to rate it a ‘buy’.

Negative developments

WPP is another stock I was bearish on last year. This was due to three negative developments. Near-term earnings downgrades, a reduction in the company’s long-term EPS growth target to 5%-10% a year (from 10%-15%), and the departure of founder and driving force Sir Martin Sorrell.

At the time I was writing, the shares were trading at 1,250p. This represented 10.5 times forecast earnings and a prospective dividend yield of 4.8%. I didn’t think this valuation was sufficiently attractive, weighed against the negative developments.

Return to growth

Today, we’re looking at a share price of little more than 800p, and 7.9 times forecast earnings of 102p, with a prospective dividend yield of 7.5% on a 60p dividend. I’ve been impressed by new chief executive Mark Read, and his three-year plan of “radical evolution” for growth. He’s lost no time in beginning to streamline the group, and has already strengthened the balance sheet through disposals of non-core businesses.

Following last year’s 10% fall in EPS, City analysts are projecting a further 7% decline this year, before a return to growth in 2020. On this outlook, I believe the dividend should be safe. The high yield and low earnings multiple offer a margin of safety, and I rate the stock a ‘buy’.

Here are two companies that I think could be great medium-to-long term investments, even if recent performance might suggest otherwise. 

Down but not out

Having fallen 25% since last month’s Q1 trading update was released to the market, it’s not been a great few weeks for spread betting firm IG Group (LSE: IGG).  

Revenue of £128.9m over the three months to the end of August was 5% lower than over the same period last year (£135.2m) — something the company attributed to the fact that markets have been relatively calm in 2018. When things are so settled, IG makes less money because clients are less likely to take positions. 

Of course, recent regulatory changes including the prohibition of binary betting to retail traders from the beginning of July coupled with new measures surrounding CFDs from the start of August haven’t helped matters. It’s still too early to say what the full impact of these changes will be.  And, as we all know, markets hate uncertainty.

Nevertheless, it’s worth remembering that IG had already warned that revenue would be hit following a reduction in trading volume by retail clients. In this sense, the recent fall feels overdone. 

Personally, I think the shares are starting to look great value again. A forecast price-to-earnings ratio (P/E) of 12 looks very reasonable considering the firm’s market-leading status, bulletproof balance sheet and consistently solid returns on capital. Moreover, it shouldn’t be forgotten that over 50% of revenue achieved from the EU and the UK in Q1 was from clients categorised as ‘professional’.

Make no mistake, IG isn’t going to the dogs. With its German subsidiary having now received a licence in principle (allowing the company to continue to trade in all EU states post-March 2019), even Brexit is unlikely to have much of an impact.   

Perhaps the biggest draw at the current time, however, is the juicy 6.5% dividend yield. Even if the payout were to be trimmed, I’d still consider this adequate compensation while the company fully adapts itself to the new regulations.

Great value

Another quality company offering decent dividends is internet marketing group XL Media (LSE: XLM). 

As summarised by my Foolish colleague G A Chester last month, the small-cap has endured a difficult 2018 with its share price taking a severe hit in June following a profit warning. September’s interim numbers failed to convince some investors to stay for the recovery, with the shares down another 15% by the end of trading yesterday.

Of course, quality companies experiencing temporary issues can be a source of riches for patient investors.  On less than 9 times forecast earnings for the current year (reducing to 8 in 2019 if analyst estimates prove correct), XL Media could turn out to be another example of this. Like IG, it has a history of generating great returns on the money it invests coupled with seriously good operating margins. 

Although some might be concerned by the 25% reduction to the interim payout (from 4 to 3 cents per share), a 4.9% dividend yield for the full year still looks good to me, assuming the final dividend is reduced by the same amount.  

Multiple issues

XLMedia’s main assets are websites that publish content relating to online gaming. Revenue comes from operators who pay a commission for the leads the websites generate. The major cause of the decline in the share price was a profit warning in June. The price plummeted 30% on the day.

Today’s results were peppered with the numerous issues that hurt XLMedia’s first-half performance. Many related to regulation, including the closure of the Australian online casino market, regulatory uncertainty in some European markets and more stringent gambling advertising regulations in the UK. The group also saw a reduction in activity, due to factors including spamming and other attacks on its websites, as well as technical issues. It also saw lower levels of mobile traffic within the gaming segment.

Not cheap enough

XLMedia’s revenue and profit fell by a low-teens percentage in the six months to June and the company said it’s on track to meet (previously-revised-down) profit expectations for the full-year. It spent over $45m on a series of acquisitions in the first half and expects to accelerate this activity, with a particular focus on diversifying into the personal finance sector.

Management is upbeat about the outlook for the company, but the shares are trading 3% down on the day at 103p, as I’m writing. The valuation is 10 times forecast earnings and the forward dividend yield is 4.3% (if we assume today’s 25% cut in the interim is carried through to the full-year). Given the multiple issues and uncertainties, I don’t think the valuation is cheap enough, so this is a stock I’m avoiding at the current price.

Plenty cheap enough

Fresnillo is a stock I’ve tipped a number of times at higher prices, most recently at what was then a two-year low of 920p. The shares are currently trading at around 860p, having bounced from a recent sub-800p low. This has very much been a case of, “just because you think a stock is cheap, doesn’t mean it can’t get cheaper.”

Fresnillo revised down its silver production guidance earlier this year but this was balanced by raised guidance on gold production. Persistent weakness in gold and silver prices has been behind the steady decline in Fresnillo’s shares. With plenty of jitters-inducing stuff going on in the world, including Donald Trump’s escalating trade war with China, I’ve been surprised by the weakness of gold and silver. It seems the dollar has been the safe haven of choice during the period. Meanwhile, Fresnillo’s share price has languished — in marked contrast to the near 2,000p it reached following the UK’s Brexit vote.

However, I continue to see the miner as offering good value as both a hedge against short-term shocks and as a long-term investment. A rating of 18 times earnings and a prospective dividend yield of 3% make it plenty cheap enough by historical standards, so it remains a ‘buy’ in my book.

Management said that revenue for 2018 is now expected to be about $130m, compared to $137m last year. Adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) are now expected to be “marginally lower” than last year’s figure of $47.1m.

Analysts’ forecasts I’ve seen suggest revenue was previously expected to rise to $144m, with after-tax profits to increase by about 10%. So this is a significant miss, although not a catastrophe.

What’s gone wrong?

This company publishes a wide range of websites, most of which carry content and reviews related to online gaming. XLMedia makes money by using these websites to generate leads and new customers for online gaming operators, who then pay the firm a commission.

It’s a lucrative business and the firm generated an operating margin of almost 30% last year. However, regulatory risks are a concern in this sector.

In an effort to diversify, management has been buying up personal finance assets, such as credit card comparison sites. Although progress is said to be good, this shift isn’t happening quickly enough to counter regulatory headwinds in the gaming sector.

Regulatory headwinds

In today’s profit warning, XLMedia said that regulatory changes in Australia had led to the “closure” of this market at the end of last year. I can’t find any mention of this in previous results, so I’m not sure if this was flagged up previously.

Regulatory uncertainty in Europe is also said to be hampering performance. And the firm says there has been “some reduction in SEO [search engine optimisation] performance in a few specific territories”. What this means is that some of the firm’s websites are not ranking as highly in internet search results as they did previously, reducing visitor numbers.

Should you buy, hold or sell?

I’ve previously been a fan of this stock, thanks to its high profit margins, strong cash generation and five-year growth record.

But today’s statement warns that “regulatory changes have triggered a re-alignment in how operators and marketers can work”. This suggests to me that profitability could be lower in the future.

Today’s warning could be a short-term blip, but it could also be a turning point for the firm. After today’s drop, I estimate that the shares trade on about 12 times forecast earnings with a prospective yield of about 4%. That’s not cheap enough for me at the moment, so I’ll be avoiding this stock until the picture becomes clearer.

A traditional moneymaker?

XLMedia provides free content and makes money by generating leads for gaming operators. But my next firm has customers who are happy to pay to read the material it publishes.

This traditional business model is working well for the publisher of the Harry Potter series, Bloomsbury Publishing (LSE: BMY). The firm’s latest results showed that sales rose by 13% to £161.5m last year, while pre-tax profit was 10% higher, at £13.2m.

These results were ahead of expectations. And the company delighted the market by announcing that 2018/19 profits were also now expected to be “well ahead of previous expectations”.

What could go wrong?

Bloomsbury doesn’t just publish Harry Potter. The group also has a growing academic publishing and adult fiction business. But one thing that jumps out at me from last year’s results is that 86% of adjusted operating profit came from “Children’s Trade”, which I assume is dominated by Harry Potter sales.

The only other profitable part of the business was “special interest”, which includes non-fiction books in areas such as history, sport and wildlife.

Over-dependence on Harry Potter could be a risk in the future, but it seems safe enough at the moment.

Should you keep buying?

Bloomsbury’s share price has risen by 20% since its results were published in May. The shares now trade on 17 times forecast earnings for 2018/19, with a forward yield of 3.3%. That’s not obviously cheap, but if earnings growth can be maintained, the shares could soon grow into this valuation.

I’d continue holding and would buy more on any dips. This appears to be a good quality business that’s firing on all cylinders.

The fatness epidemic

The first is OptiBiotix Health (LSE: OPTI), which develops products aimed at tackling the problems of obesity, high cholesterol and diabetes — all very big issues in the overfed developed world. The company’s bottom line is starting to turn upwards, and there have been some key developments that convince me that serious profit might not be too far away now.

On Thursday the company announced “an evaluation agreement with a global dairy company for its SweetBiotix calorie-free sweet fibres,” which could see them ending up in a range of products. We don’t know which company it is, but according to CEO Stephen O’Hara, it’s a well-known global brand.

This news comes a week after the firm’s annual results were released, for a year it says is part of a “transition from a development company into a commercial business.“

OptiBiotix reported a profit-sharing agreement with Sacco among 10 commercial deals agreed in the period. Its SlimBiome product won a Food Matters award for Best Functional Ingredient for Health and Wellbeing, and FDA registration for LP-LDL and SlimBiome are paving the way for sales in the US.

There was even a small pre-tax profit, of £1.69m. And OptiBiotix looks to be in a comfortable financial position, having just raised £1.5m through a new equity offering.

My colleague G A Chester recently rated it a high-risk buy, and I agree with him.

Cash cow already

When I examined XLMedia (LSE: XLM) early last year, the shares had nearly three-bagged since 2014 and I saw the stock as a very tempting proposition. Since then the share price has put on a further 50%, as the company is firmly in that territory envied by many a growth startup — it’s in the transformation from growth prospect to dividend-paying cash cow.

The company, which bills itself as a provider of “digital performance marketing services,” saw its 2017 revenues grow by 33%, with adjusted EBITDA up 36% and earnings per share up 25%. And it had plenty of cash on the books and no debt.

The shares have actually fallen back a little since the end of 2017 as earnings forecasts have been pared back a little. But that’s a common phenomenon with growth stocks, and I reckon it still leaves the shares on a pretty attractive valuation.

We’re not looking at the super-low PEG ratios of recent years as EPS has been making annual double-digit percentage leaps, and the latter is expected to be flat this year. But a return to growth with 8% indicated for 2019 would put XLMedia on a P/E of a little under 15 — and that’s with dividends set to already yield 3.5% by then.

For a company in a growing market, with significant further growth potential, and already bring in pots of cash and paying decent dividends, I reckon that’s a bargain price. And $43.3m (£34.5m) in cash at year-end for a debt-free company with a market cap of £360m isn’t too shabby either.