This Tiny Stock May Be a Huge Bargain

At its current share price of S$0.81, Micro-Mechanics (Holdings) Ltd (SGX: 5DD) is a tiny stock with a market capitalisation of just S$110 million.

But, it has had big returns over the last 12 months – nearly 20%! – even as the broader market, represented by the Straits Times Index (SGX: ^STI), has slipped by 25%. More importantly for investors, Micro-Mechanics may also be a tiny stock that’s a huge bargain.

Finding value

A reverse discounted cash flow (DCF) model can be used to understand a stock’s implied growth rates at a particular price. In the case of Micro-Mechanics, at a price of S$0.81, the market doesn’t seem to be expecting much from the high precision tools and parts maker.

I had used the following inputs and assumptions for my reverse DCF model:

  • Free cash flow per share over last 12 months, according to S&P Capital IQ: S$0.080
  • Discount rate: 15%
  • Terminal growth rate: 3%

To cut to the chase (see here for a detailed look at how a reverse DCF model can be constructed), with the figures I had listed earlier, my calculations show that the market expects Micro-Mechanics’ free cash flow per share to grow at just 7% annually over the next five years, and then at just 3.5% per year over the next five years.

Year Micro-Mechanics’ implied free cash flow growth rate
Year 1 7.0%
Year 2 7.0%
Year 3 7.0%
Year 4 7.0%
Year 5 7.0%
Year 6 3.5%
Year 7 3.5%
Year 8 3.5%
Year 9 3.5%
Year 10 3.5%

Source: Author’s assumptions and calculations

The table above gives you another way to look at Micro-Mechanics’ implied growth rates based on my reverse DCF model.

The presence of value

Over the company’s past five years from FY2010 (year ended 30 June 2010) to FY2015, its free cash flow per share has grown at a compound annual rate of 12.9% from S$0.036 to S$0.066, according to data from S&P Capital IQ.

In comparing the historical growth rate of 12.9% with the implied future growth rates of 7.0% and 3.5%, could the market be underestimating the strength of Micro-Mechanics’ business currently? Moreover, to sweeten the deal, the company has a great balance sheet at the moment with S$16.6 million in cash and zero debt.

A Fool’s take

It’s worth pointing out that the past is no guarantee of the future. Just because Micro-Mechanics has grown at a mid-teens rate in the past five years does not mean that it can continue doing so. A careful understanding of the future growth drivers of Micro-Mechanics’ business would be needed before any investing decision can be reached.

So yes, Micro-Mechanics does appear to be valued very cheaply by the market now. But then again, cheap shares can also become expensive nightmares if their businesses crumble.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn't own shares in any companies mentioned.