Burning cash

At the end of 2017, the cash balance stood around £25m, but I expect it’s lower today. The money came from a placing during the year that raised £24m. The year before, the firm raised £38m. It looks like cash is burning up at the rate of around £18m-£19m per year. As we might expect, the shares have been falling. Today’s 141p or so puts them around 56% down since the summer of 2017.

I’m not averse to investing in a company without immediate profits as long as there’s potential for earnings down the road. I would want to see some progress, such as increasing revenues or reducing losses — even with big story stocks — before taking the plunge. There’s no such evidence here, though. All the numbers seem to be going the wrong way.

Yet, chief executive Mark Nicholls said in today’s report: “We are now at a pivotal point in the commercialisation of our technologies.” The trouble is, at the end of the 2016 trading year, he also said: “Our scope and strategy is now fixed. 2017 will be a year of execution, in which we significantly progress the commercialisation of our highly disruptive, innovative technology.”

More of the same to come?

The story could be a good one and revenues could explode soon, but how long must we wait for profits? My guess is that the share price falls and the placings to raise more money to survive are not over yet, so I’m avoiding Xeros Technology Group for the time being in favour of defensive dividend-payer SSE(LSE: SSE).

The firm produces, distributes and supplies electricity and gas to homes and businesses in Great Britain and Ireland. It’s a classic defensive, high-dividend-paying business and the stock looks like it was caught in the sell-off of such defensive firms that brought their valuations down over the past year or two. However, since the middle of February, the share price has been creeping back up.

Today’s 1,315p throws up a forward price-to-earnings ratio just under 11 for the trading year to March 2020 and the forward dividend yield is around 7.4%. City analysts following the firm expect earnings to lift 4% for the year to March 2019 and 1% the year after, dipping 7% in the current year, so a fairly stable outlook on earnings.

The outlook is mildly positive and I reckon there’s a good chance that the valuation will return to a level where the dividend yield sits around 6% or so, as it did before, suggesting a little more potential upside for the shares. Meanwhile, I reckon the so-far reliable dividend makes the firm a decent long-term hold.

If you’re looking for the next diamond in the rough, then consider these two under-the-radar picks.

Market leader

First up is Strix Group (LSE: KETL), a company which designs and manufactures kettle safety controls, thermostats and water boiling elements for domestic appliances.

While many of us may never have heard of the company before, Strix is a worldwide market leader, supplying 38% of the global kettle market with its proprietary water temperature management sets. It’s not a particularly exciting, fast-growing industry, but Strix does appear to be finding healthy profits in a niche market.

For the six months to 30 June, the company generated revenues of £42.2m, with pre-tax profits of £10.3m — an increase of 9.6% on the £9.4m figure earned in the same period last year. Encouragingly, export sales have been particularly strong, with the firm gaining market share in emerging markets.

With growing scale and a widening lead over its competitors, Strix is well-placed to leverage its strong pricing power and improve on its already impressive first-half EBITDA margin of 33.6%. As such, investors should not only expect meaningful bottom-line growth going forward, but also some multiple expansion as well.

The company, which was founded in 1982, has only been listed on London’s Alternative Investment Market (AIM) since August this year. But despite the short span of time, investors who backed the 100p-a-share initial public offering (IPO) are already sitting on big gains, as the shares are now priced at 138p.

Still, I reckon further gains could still be to come as valuations remain undemanding. At its current share price of 138p, Strix is valued at less than 12 times its annual earnings and offers a prospective dividend yield of 5.1%.

Technology disruption

Elsewhere, Xeros Technology (LSE: XSG) is an exciting small cap-pick for investors looking to bet on innovative, environmentally-friendly technologies that have the potential to disrupt existing industries & practices.

Xeros’s patented polymer based technologies, which use less water and energy compared to conventional tech, is a potential game-changer in three world-scale industries: cleaning, tanning and textiles. A Xeros commercial laundry machine replaces water with millions of reusable polymer beads, reducing water use by up to 75% when compared to a traditional laundry machine.

The company is still some way away from delivering significant profits, as the firm today reported a widening in its H1 after-tax loss, to £15.1m, following a ramp-up in its commercialisation programme and higher research and development costs. On the upside, Xeros’s total installed estate of commercial cleaning machines increased by 36% to 378 machines, reflecting robust demand and growing acceptance of the technology.

Furthermore, Xeros plans to demonstrate its domestic machine prototype design at the Consumer Electronics Show in January next year, which would be a major boost to the company’s future expansion plans, as it would widen the potential applications of its tech to a much wider market.

Dividend increase

Shares in insurance group Randall & Quilter (LSE: RQIH) gained as much as 7% today after the company reported a more than tripling in profits in 2016. As after-tax profits increased from £2.8m to £8.3m, the Bermuda-based insurance investor and service provider also announced its first dividend increase since 2012, boosting its full-year dividend from 8.4p per share to 8.6p per share. This gives its shares a tempting prospective dividend yield of 6.8%.

The insurer is also upbeat about its prospects going forward. “2017 is expected to be a year characterised by further profit growth and strong strategic focus,” the company said in today’s announcement. R&Q sees further acquisition opportunities this year and expects to reap the rewards from the expansion of its product offering and stronger distribution in North America after years of investment and underperformance.

However, not everything is rosy. The company managed to deliver an extremely strong performance in its Insurance Investments Division following the completion of a series of 15 legacy transactions during the year and an improvement in investment returns. But profits fell sharply from its Insurance Services division, while losses widened at its Underwriting Management unit. This indicates an unbalanced reliance on investments as a source of growth, which could become a cause of concern should the company struggle to acquire new businesses and investment returns decline.

Growing acceptance

Meanwhile, Xeros Technology (LSE: XSG) announced the rollout of its commercial laundry machines continues apace. Shares in the developer and provider of polymer-based technologies gained by as much as 4% today as the company reported group earned income increased to £2.5m in the 17 months to 31 December 2016, up from £480,000 for the year to July 31 2015.

The company’s progress in the laundry market continues at a steady pace, with Xeros seeing multiple successful customer trials in the performance workwear market and increasing in its order backlog to 438 machines at the end of March. In addition, Xeros is seeing promising trial results for its polymer technology in tanning and textile manufacture applications, which could underpin the long-term growth prospects of the company.

Xeros is still some way away from delivering significant profits, as its pre-tax loss in the 17-month period widened to £21.1m, from a loss of £10.7m in the year to July 2015. However, the company is moving towards generating meaningful revenues — CEO Mark Nichols advised that “2017 will be a year of execution, in which we significantly progress the commercialisation of our highly disruptive, innovative technology.”

Year-to-date, shares in Xeros haven gained 26% — but they may yet have further to go. Xeros is looking to expand its distribution network and has recently secured a significant forward channel partner agreement to enter the Australian commercial laundry market. And as the rollout continues, Xeros could prove that there is growing acceptance and demand beyond the US and UK commercial laundry market. This would be a major boost to the company’s growth plans, increasing the penetration of its target markets.

Clearly, Gulf Keystone has a highly uncertain financial future, but even if it survives the short-to-medium term, its asset base remains in a high risk location. And with geopolitical uncertainty set to remain high in Northern Iraq over the long run, Gulf Keystone may struggle to gain improved investor sentiment moving forward.

While Gulf Keystone has a sound asset base in terms of its long-term profit potential, the lack of payment for produced oil is likely to be a concern for investors for some time to come. That’s simply because the future of the region is very uncertain and while there are a number of other oil and gas stocks offering wide margins of safety, there may be better options elsewhere.

Fully valued?

Of course, other smaller companies outside of the resources sector may also hold appeal. For example, Quartix Holdings (LSE: QTX) is forecast to increase its earnings by 10% in the current year and by a further 12% next year. This rate of growth has the potential to improve investor sentiment in the stock, although following the vehicle tracking system specialist’s share price rise of 28% since the turn of the year, its shares are starting to look rather fully valued.

In fact, Quartix trades on a price-to-earnings growth (PEG) ratio of 2.2 and this indicates that further share price gains could be limited. Therefore, while the company is performing well, it may be prudent to await a lower share price before piling-in.

Watch for now

Similarly, Xeros Technology (LSE: XSG) may not be a significantly superior buying opportunity than Gulf Keystone. Certainly, it has a bright long-term future, but with the polymer bead system specialist being lossmaking in each of the last two years, it may suffer from further weak sentiment following its 18% share price fall since the turn of the year.

Of course, the latest update from the company showed that it’s definitely making progress. For example, it reported that its commercial laundry division is now installing machines at the rate of approximately one per working day, while its trials are on track within the leather processing segment. However, with a number of other smaller companies offering high levels of profitability at an enticing price, Xeros may be a stock to watch rather than buy at the present time.

Shares in industrial company Xeros (LSE: XSG) have soared by 11% today after it released an upbeat set of interim results. The developer of patented polymer bead systems increased earned income to £744k from £95k in the prior period, delivering on the strategy that was laid out at its fundraising in November last year.

Furthermore, the roll out of the company’s commercial laundry offering continues to take place at a good pace and Xeros is now installing around one machine per working day, with this rate expected to increase. In addition, the company’s trials in leather processing are on-track and should be complete in the middle of the current year. And with studies to identify new potential applications being on schedule, Xeros is showing the market that it possesses a platform technology.

Despite their double-digit rise of today, shares in Xeros are still down by 6% since the turn of the year. However, they could continue their rise since the company’s strategy appears to be sound and as today’s update shows, investor sentiment is warming to Xeros’s outlook.

Refreshed strategy

Another industrial stock which has experienced a turnaround in investor sentiment is Rolls-Royce (LSE: RR). Its shares have risen by 20% year-to-date and a key reason for that is the expected improvement in the company’s bottom line during the next couple of years.

Certainly, Rolls-Royce’s earnings are set to endure more pain in the short run with a fall of 56% pencilled in for the current year. But with a new management team and a refreshed strategy, Rolls-Royce has the potential to increase its net profit by as much as 32% next year according to market forecasts.

This puts the company on a price to earnings growth (PEG) ratio of just 0.7, which indicates that Rolls-Royce offers growth at a very reasonable price. And with the global economic outlook being relatively upbeat for the long term and the wider aerospace and defence sector offering improving levels of demand for new products, Rolls-Royce could now be worth buying after a hugely disappointing 2015 which saw its share price slump by 34%.

Huge appeal

Also enduring a tough 2015 was defence sector peer Meggitt (LSE: MGGT). Its shares fell by 28% in that calendar year but, like Rolls-Royce, Meggitt is in the midst of a turnaround. This has helped its shares to rise by 7% since the turn of the year and with its bottom line expected to increase by 4% this year and by a further 8% next year, the company’s current valuation has huge appeal.

In fact, Meggitt trades on a price to earnings (P/E) ratio of just 12.3, which equates to a PEG ratio of 1.4 when combined with the company’s forecast growth rate. Allied to this is a dividend yield of 3.8% and with the company’s dividends being covered over twice by profit, there is considerable potential for rapid dividend rises in the coming years.

So, while Meggitt and Rolls-Royce have been disappointments in the past, both stocks appear to be worth buying for the long term. And while Xeros has potential, the size of the turnaround prospects for its larger peers, as well as their scale and financial strength, make them the preferred options at the present time.