Some of the best smallcap opportunities emerge when an established business begins to improve faster than investors recognize.

Firan Technology Group ($FTG.T), which we found early in 2023 at SmallCap Discoveries, provides a useful example. Since our discovery, Firan’s shares have increased more than tenfold….. a 10-bagger.

Looking back through our SCALED framework helps explain the opportunity: strengthening demand, thoughtful capital allocation, meaningful insider ownership, improving economics and a business whose potential was becoming more visible.

We had not yet introduced SCALED in its current form. But the principles behind it were already central to our approach, find improving businesses, understand management’s decisions and focus on what growth means for each share we own.

Firan supplies electronics to the aerospace and defence industries. Its products include high-reliability printed circuit boards, illuminated cockpit panels, keyboards and electronic assemblies. These are specialized products serving demanding customers, giving us a concrete business to study.

S — Sales Growth Per Share

The first place to look was the direction of demand.

In February 2023, Firan reported that fiscal 2022 revenue had increased 13% to $89.6 million. More revealingly, bookings had risen 41% to $113.3 million, and fourth-quarter bookings marked the eighth consecutive quarter of sequential growth. Orders were running ahead of shipments, building a backlog that supported the case for further revenue growth.

That distinction matters. Revenue tells us what a company has delivered. Bookings and backlog can help us understand what may come next, provided the company can convert those orders into profitable sales.

Under SCALED, revenue growth is only the starting point. We want sales growth per share. Acquisitions financed through substantial equity issuance can make a company larger without producing a comparable improvement for existing shareholders.

Firan’s proposed acquisitions were cash transactions, and the company was also repurchasing shares. That combination made the relationship between business growth and shareholder ownership particularly relevant to the analysis.

C — Capital Allocation

Firan was putting its financial resources to work.

Entering 2023, it had announced agreements to acquire IMI and Holaday Circuits. The transactions subsequently closed in April, adding radio-frequency circuit-board capabilities and substantial U.S. manufacturing capacity for high-technology aerospace and defence applications.

The strategic fit was understandable: expand capabilities and capacity within markets Firan already served.

This is how we assess capital allocation. An acquisition should offer a credible path to better economics through additional capabilities, customers, capacity or operating efficiencies. Its success ultimately depends on the price paid and the execution that follows.

Firan’s willingness to repurchase shares also belongs in this discussion. Management had several competing uses for cash, including acquisitions, equipment, research and development, and buybacks. Evaluating those choices together is more useful than celebrating any single transaction.

A — Alignment

Meaningful ownership is an important part of our SCALED framework. We want management and directors to benefit from the same long-term, per-share value creation that benefits outside shareholders.

Firan provided tangible evidence of that alignment. As of February 9, 2023, its directors and executive officers collectively owned or controlled 3,127,822 common shares, representing approximately 13.1% of the company. Oakwest, where Firan director Robert Beutel served as a director and executive officer, held a separate 20.1% stake. That corporate holding should be distinguished from management’s personal ownership.

CEO Brad Bourne also had substantial ownership. The following year’s circular disclosed that he held 2,723,900 shares, representing 11.4% of Firan, as of February 22, 2024. That gave him meaningful financial exposure to the outcome of his operating and capital-allocation decisions.

Ownership was supported by actions worth examining. Firan disclosed $1.1 million spent on share buybacks during fiscal 2022. When its acquisitions closed in April 2023, the company said they would be funded primarily with existing cash, with bank facilities covering the remaining balance.

For us, alignment means leaders with a meaningful ownership stake, supported by decisions that protect and grow value per share. Ownership cannot guarantee good execution, but it gives management a powerful reason to think like shareholders.

L — Leadership and Strategy

We look for management with a clear strategy and the ability to execute it.

Under CEO Brad Bourne, Firan’s stated acquisition objective was specific: add U.S. manufacturing capacity and strengthen its capabilities in radio-frequency and high-technology circuit boards for aerospace and defence customers. IMI and Holaday directly addressed that objective.

A strategy that can be explained clearly can also be tested.

Were the acquired facilities increasing throughput? Were pricing and productivity improving? Were the investments translating into stronger margins and earnings?

By the end of fiscal 2023, Firan reported progress in integration, pricing, throughput and cost savings at the acquired businesses. Those later developments provided evidence against which to judge the original strategy.

E — Earnings and Cash Flow Per Share

Growing demand becomes more valuable when it produces better economics.

Firan’s April 2023 results provided further confirmation of the improving operating picture. First-quarter revenue increased approximately 20%, while adjusted EBITDA rose from $1.1 million to $3.2 million. Gross margin excluding government assistance improved from 19.5% to 28.0%.

That was evidence of operating leverage: higher sales were helping the company absorb its costs more effectively.

It was also important to read beyond the headline earnings. Government assistance materially benefited reported first-quarter profit. The adjusted figures offered a clearer view of the underlying improvement.

The earnings test must then extend to cash. Manufacturing growth can require more inventory, receivables and equipment. SCALED therefore asks whether improving earnings ultimately become sustainable cash flow per share after those demands are met.

D — Discovery

Discovery concerns the relationship between business progress and market recognition.

Finding Firan early in 2023 gave us an opportunity to investigate the business before the full-year improvement had unfolded. The February disclosures already showed strengthening orders, recovering sales and planned acquisitions. The subsequent quarters allowed investors to assess whether those signals were translating into results.

By fiscal year-end, revenue had reached $135.2 million, up 51%, including $22.9 million contributed by acquisitions. Adjusted diluted earnings per share reached $0.29, while backlog stood at $97 million. These were later confirmations, not facts investors could have known at the beginning of the year.

That is the opportunity we seek in the discovery process: recognize credible business improvement while there is still uncertainty about its eventual scale.

Firan’s subsequent rise of more than tenfold illustrates what can happen when business progress compounds and attracts broader market recognition. The challenge is to identify the evidence early, develop conviction through research and keep testing the thesis as the company executes.

SCALED gives us a disciplined way to connect demand, capital allocation, ownership, leadership and per-share economics. We continue to apply those principles in our search for businesses with substantial potential ahead of them.

Join us at SmallCap Discoveries as we search for the next Firan, before it becomes a 10-bagger.