Stockwatch: Follow the funds into this share

Is a well-regarded hedge fund worth following into this stock? Ennismore European Smaller Companies Fund has raised its stake in BrainJuicer, a £53 million AIM-listed marketing research group, from sub 3% to near 6%.

While the fund managers could be increasing exposure to cyclicals in anticipation of economic recovery strengthening, AIM stocks are less liquid so it implies a long-term rationale and commitment. BrainJuicer claims a revolutionary approach to marketing services based on the fashion for "behavioural science".

The business has existed for 16 years and as a listed company it has shown good overall growth albeit two examples of near-flat revenue progress from £20.7 million and £24.5 million (see table). An overall 50% revenue growth rate with circa 95% profits/earnings growth over four years is respectable, if from a low base arithmetically and helped by economic recovery from "the great recession". The real test of the claim to quality earnings will come when economies turn down.

Yet bullish noises from recruiters - lately Penna - imply UK firms in particular are confident, and improved employment should translate into higher disposable income. Despite some acute risks in international finance, the underlying economic context is firm. BrainJuicer's geographic revenues comprise: 36% UK, 31% US, 18% continental Europe, 8% China and Singapore, 6% Brazil and 1% India.

Chart retreat, but the earnings valuation still expects plenty

The five-year chart reflects a typical pattern where quality cyclicals were bought vigorously during 2013, then consolidated. After hitting a 514p high in 2014, BrainJuicer de-rated then rose from 380p to a current 2015 high of 416p. Mind how the forward price/earnings (P/E) multiple exceeds the projected earnings growth rate: the table shows the price/earnings-to-growth (PEG) ratio as 1.5 reducing to 1.3.

This classic measure of growth stock value advocates buying on a rating below 1.0, although PEGs can be snapshots that compromise the long-term development picture. A few stocks have become long-term winners despite sporting PEGs (well) over 1.0, if tending to be exceptional businesses e.g. ARM Holdings. Mind also not to fall into the trap of confusing cyclical firms as growth stocks - a classic error near a market top, after a cyclical upturn.

So the crux is whether BrainJuicer is gaining an industry presence able to create a £100 million+ company and weather the next downturn. Implicitly, Ennismore believes so, this being the kind of reward necessary to offset the risk of a near 6% position in a less-liquid stock.

A competitive advantage in the making

In the company's words, BrainJuicer's approach "is what drives clients to seek us out when traditional methodologies have failed them, to facilitate change within their organisations and turn true human understanding into business advantage." It moves away from traditional methods such as questionnaires, for example to measure people's emotional response to advertisements.

The services cover a wide range of marketing from helping firms test concepts to predicting how effective a TV ad will be. A classic example was Cadbury's ad featuring a gorilla playing drumswhich had nothing to do with chocolate but evoked a strong response and turned out to be the most effective in Cadbury's history. BrainJuicer's founder referred to this in a blog detailing three new tips for marketing research after being named company-of-the-year for advertising, marketing and public relations at the 2011 International Business Awards. The methods are tricky to replicate without rivals undermining themselves, and competitive advantage should also grow as BrainJuicer's databases get bigger and more effective. In principle this generates ability to charge premium rates, attract the best industry talent and gain loyal customers - i.e. higher quality revenues. In practice, investors need to see fine words and theories support strong numbers.

Very modest revenue growth lately has checked hopes

The 2014 annual results statement conceded that 1% overall revenue growth for 2014 - 5% in constant currency - was "disappointing". It was blamed on a lumpy workflow profile with the core quantitative services side (88% of revenue) up 4%, or 8% in constant currency: "it is these services we can scale and that we are relying on for our on-going growth". Alongside these are Juice Generation projects whose main purpose is "to forge deeper relationships with senior marketing people within client organisations and, obliquely at least, support the growth of our more scalable and higher margin quantitative services." Representing 10% of group revenues, such workflow is less predictable and fell by 28% last year. So it's possible to regard the group as positioning itself well: "we made inroads into some very large clients, winning preferred supplier positions," it said, although the anticipated revenue increase has yet to materialise.

So there is quite some hope factor involved with buying like Ennismore has done. The positive long-term upshot is that if BrainJuicer's development works to plan and rivals can’t easily emulate, then it becomes a takeover target.

Scope to raise ordinary dividend payments

Despite a good record of dividend growth (see table) the ordinary dividend payout is very modest - covered over five times by earnings, in a context where cash flow has recently exceeded earnings and capital expenditure needs are shown as very low. The board has appeared to try and compensate by way of a 12.0p special dividend last May, involving £1.5 million, which boosted the historic yield to near 4%.

Additionally, it "returned" over £1.9 million via share buybacks and cash settled management equity awards. As I have previously stated, boards could better focus on re-rating the ordinary dividend if they are genuinely confident, this being a more effective valuation prop than haphazard "special" payouts and pseudo "returns". BrainJuicer shows potential for this if the board can act more clear-cut.

The dilemma may also reflect management owning over 30% of the equity: an owner-mentality is good in many respects, but it can foster payouts varying according to directors’ preferences, tax liabilities and to get equity awards. At end-2014 there was £5.3 million cash at bank and no debt or pension fund issues, so there is scope for further returns, however structured. This helps the "buy" case despite cyclical risks and the need for more revenue proof.

For more information see: brainjuicer.com

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser..