As markets surge, with the S&P 500 reaching new heights, it’s easy to get caught up in the short-term frenzy.

Take Super Micro Computer (NASDAQ: SMCI), for example, whose share price has soared over 700% in the past year, despite far less remarkable earnings growth. This is textbook “sentiment” action, marked by surging buying volumes and an auction-like frenzy, which often puts speculation above fundamentals.

Patient investors resist the lure of FOMO (fear of missing out) when sentiment moves out of sync with reality. They remember that over the long haul, earnings growth is the most significant driver of share price changes.

Overly positive market sentiment often leads to multiple expansion and, if earnings growth can’t keep up, can result in a sharp reversal. As Warren Buffett famously said, “Only when the tide goes out do you discover who’s been swimming naked.” This highlights the risks of relying solely on sentiment for investment decisions, as the true strength of a company’s financials is revealed when market conditions change.

Amidst the focus on more sensational stocks, opportunities often lie in areas where sentiment has yet to catch up, such as small caps or companies with improving fundamentals that remain unrecognised by the broader market.

Last week, two of TAMIM’s Australian equity holdings, Viva Leisure (ASX: VVA) and Reckon (ASX: RKN), released earnings reports with little fanfare. Despite the quiet reception, these updates hint at promising opportunities for patient investors, fitting the mould of companies with improving fundamentals yet to be fully recognised by the market.

Reckon Limited (ASX: RKN) a market leading software provider to small to medium sized businesses and legal professionals released their full year results last Tuesday.

Group revenue reached $53.4 million, a 4% increase from the previous corresponding period (PcP). Recurring revenue demonstrated a parallel growth of 4%, totalling $49.1 million. The company experienced a noteworthy upswing in operating earnings (EBITDA), soaring by 10% to $19.7 million compared to the PcP. Net Profit After Tax (NPAT) witnessed a substantial improvement of 36%, reaching $4.9 million. The Group’s operating cash flow for continuing operations, net of development spend, decreased to $4.8 million despite the drop in development costs. The net debt stood at $2.8 million. The company declared a fully franked dividend of $0.025 per share in September 2023.

A significant growth area for the legal business is cloud practice management in the US. Reckon’s Legal Group reported impressive subscription revenue growth, increasing by 17% to $10.8 million.

Marketing expenditure continues to be a focus as legal firms in the US predominantly use desktop software. The Legal Group demonstrated consistent growth, serving 8 of the 25 largest law firms in the US and 6 of the top 10 law firms globally.

Reckon Group CEO, Mr Sam Allert commented:

Viva Leisure Ltd (ASX: VVA), a leading player in the health and fitness industry, reported impressive financial results for the first half of 2024 (HY2024).

In addition, strategic initiatives such as acquisitions, refurbishments, and technology investments contributed to the company’s overall positive performance. Driven primarily by organic growth, Viva’s revenue increased by 17.3% reaching $79.1 million. This flowed through to operating earnings (EBITDA) which increased 18.6%, totaling $16.6 million for the first half. The increase flexed Viva’s enhanced margins and operational efficiency.

As we’ve written previously, Viva Leisure offers a diverse range of facilities within the health and leisure industry. Viva Leisure’s mission is to connect fitness and wellness to as many people as possible and aims to provide its members with affordable, accessible and high quality facilities.

Membership and Utilisation 

Membership increased by 9.8% to 180,071 in owned locations, and by 6.2% to 345,317 in all locations.

Utilisation continued to grow in owned locations increasing to 70.9%, indicating continued strong demand and customer satisfaction. Viva estimates utilisation based on maximum capacity per location, being 2 members per square metre for Health Clubs and 1 member per square metre for Boutiques. Improving utilisation rates across the portfolio enhances margins with limited additional costs for new members. Utilisation decreases temporarily as new locations open and rises as locations add members. Viva’s long term utilisation target is 75-80%.

Despite exiting the Fitness Passport corporate program as a part of the restructure plan, Viva added 6 owned locations and 7 in all locations, demonstrating resilience and strategic expansion. Furthermore the removal of Fitness Passport resulted in the removal of 8,395 low-yielding members, with a minimal impact on net revenue.

Financial Position 

Viva’s cash balance as of 31 December was $4.3 million down from $6.8 million at 30 June 2023.

The company generated operating cash flow of $27.5 million, an increase of 12% on the prior period. Considering Viva’s significant capital requirements, a substantial portion of its operating cash flow is reinvested into the business for building leases and equipment payments. In addition, Viva noted that it is in late-stage due diligence for several acquisitions, expected to be funded through a combination of debt facilities and existing cash reserves. Viva has begun the process of drawing against the bank fit-out facilities to support capital allocation for earnings accretive investments and to optimise leverage on the balance sheet.

Both Viva Leisure and Reckon present compelling investment opportunities for patient investors. In the whirlwind of rising market sentiment, investors must stay grounded in their principles and avoid FOMO.

At TAMIM, our resolve is to ‘buy well,’ focusing on the long-term potential of smaller companies with improving fundamentals, particularly those showing promising earnings growth. When there’s a growing divergence between share price and earnings growth, patience becomes even more vital. Eventually, this gap must close, and it’s in these moments that patient investors, firm in their convictions, can realise significant gains.

Disclaimer: Viva Leisure Ltd (ASX: VVA) and Reckon Ltd (ASX: RKN) are held in TAMIM Portfolios as at date of article publication. Holdings can change substantially at any given time.