When it comes to finding shares of great companies in the S&P/ASX 300 (INDEXASX: XKO), there are a few things I look for:
- High returns on capital – which can be a sign of a competitively advantaged business
- Talented and well-aligned management – I only invest in companies which are run by managers with lots of ‘skin in the game’
- Long-term growth potential
- High amounts of recurring revenue and sales
- No debt — or, at least, a net cash position
3 ASX 300 Shares I’m Watching Closely in 2019
The following companies come close to meeting my initial criteria but are not yet in my portfolio, for reasons I outline.
Appen Ltd (ASX: APX)
Appen is a machine learning company. Although that sounds like ‘another technology buzzword’, it’s already profitable and growing.
Appen allows small tech companies, such as Flamingo AI Ltd (ASX: FGO), and large technology companies, like Google, Facebook, etc., to make their technology smarter. Appen does this by crowdsourcing human feedback.
For example, if an insurer wanted to improve their AI-driven customer service bot created by Flamingo AI they might outsource some testing to Appen, which would ask its thousands of contractors to test the service and provide feedback to improve the algorithms.
I think of Appen more like a HR management company that is riding the machine learning and AI trends.
Citadel Group Ltd (ASX: CGL)
Canberra-based Citadel Group is a small software company that offers its software and services to ‘manage complexity’ (don’t they all). Clients typically include large private companies and Government departments across health and defence.
I’m naturally biased towards software companies like Citadel because their margins, operating leverage and profitability can be unparalleled — if they have the right product and scale appropriately.
There are a few reasons I don’t own Citadel. Firstly, to me, it seems to be more of a roll-up or acquirer of other technology companies. Those types of growth strategies are harder to execute for long periods of time. Second, Citadel has a bit of debt on its balance sheet.
Arguably, those risks are countered by growing sales and high amounts of recurring free cash flow. Nonetheless, it will remain on my watchlist until I can get more comfortable.
a2 Milk Company Ltd (ASX: A2M)
a2 Milk is the true a2-protein dairy products producer and seller in Australia, New Zealand and beyond. While the jury is out on the science behind a2-protein only milk, the likes of a2 and Blackmores Ltd (ASX: BKL) have proven you don’t need much science behind your product to make a great business.
With growth opportunities abroad in China and the USA, a2 Milk Company’s unique product and growth strategy could still be in its infancy. Indeed, despite its shares rising more than 10 times over recent years, there could be more in store for patient shareholders.
However, with China recently passing new e-commerce laws and a new CEO at the helm, I’m happy to wait on the sidelines, for now.
Summary
In summary, these three growing companies appear tempting on first glance — who doesn’t like rapidly-rising sales and share prices. However, I’m happy to keep them on my watchlist in 2019, or until I get more conviction in their valuations.
If you want the name of 1 small-cap technology company I own today, keep reading…
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