Compounding is a wonderful wealth builder. Even small positions in wonderful companies can become meaningful wealth builders when those companies earn high rates of return and are given a long period of time.
Here are three small cap companies with high rates of return on equity, low levels of debt, alongside room for exponential growth over many years.
IDP Education Ltd (ASX: IEL)
IDP Education provides placement services for international students into educational institutions in Australia, the UK, America, Canada, and New Zealand. Some of the other services that it provides include student counselling, application processing, and English language testing.
IDP Education has achieved a fantastic return on shareholders' equity of 48% in 2017, with similarly high returns forecast for the next few years. The company's market capitalisation has been rapidly growing, and currently sits at around $1.89 billion. However, the market cap will be much larger if it continues to compound at 45%, which it could well do on the back of the strong education sector in Australia.
Integrated Research Limited (ASX: IRI)
Integrated Research is a global provider of proactive experience management solutions for critical IT infrastructure, payments and communications ecosystems. Its unified communications segment provides solutions to maximise online user experience, for example by providing call quality troubleshooting and proactive alerting.
Its call centre segment provides solutions to optimise customer call centre experiences. Its payments segments keeps customers up-to-date with payment technologies and enables transition to the latest technologies. Lastly, its infrastructure segment provides infrastructure and IT service management.
The growth in online retailing has been fast, but online retailers will need to maintain a focus on delivering a high quality customer experience. This is where Integrated Research can really benefit on the back of a growing market. Its current market capitalisation is around $667 million, and it achieved a return on equity of 38% last financial year.
Codan Limited (ASX: CDA)
Codan is engaged in the development of electronic solutions for government, non-government, and consumer markets. Its businesses include radio communications, metal detection, mining automation, and defence electronics.
Codan has a market cap of around $438 million, placing it firmly in the small cap space. Its diverse businesses each target reasonably large markets, and these give Codan room to grow in multiple areas. In the 2017 financial year, the company achieved a return on equity of 27%. If it continues to compound shareholders' equity at 27% the company would be a great addition to any portfolio. However, analysts have forecast a small reduction in return on equity to around 20% for the next 3 years.
Foolish takeaway
Idp Education, Integrated Research and Codan are three small cap businesses with lots of room for growth that could compound returns at high rates. I'd buy these three businesses to hold them for many years, and let management do the work to compound my wealth.
