While it’s important to be cautious and rational with your growth expectations, it’s also important to remember that small-cap stocks can generate staggering returns.
We’re talking about the home run that turns $10,000 into a million dollars, transforms lives, and creates windfalls that create investment legends. And while there are many factors that make this happen, the most important point is the sense of regret that everyone felt when they heard about these stocks, finding them before anyone else.
There are many great resources to get you started on this journey. This includes an excellent book by Chris Mayer. 100 Baggers: Stocks that return 100 to 1 and how to find themOur approach includes many facets of what Mayer talks about and extends them with our own proven and unique style.
Finding fast-growing companies early is an important part of what multibaggers need, but another important factor for multibaggers is multiple expansionThis is where the values or multiples dictated by a firm, such as price vs. earnings, EV/revenue, price vs. sales, scale as firms continue to grow in size. And it’s about understanding what drives this multiple expansion. If the fundamentals haven’t changed, this means that for some reason people rated them four times higher than he did. However, if the fundamentals change (e.g. earnings tripled) and the multiple expands from 5x earnings to 20x earnings, then this combined earnings increase and multiple expansion would result in a 12x increase in the stock price. I mean! This happens more often than you think, but you should know where to find these opportunities.
Multiple expansions are clearly something we want to achieve because they increase the value of our investment, but what is the reason?
Attractive valuation
First, and most obviously, a smaller valuation means more potential for multiple expansions. For example, if a stock trades at 5 times his earnings, it is much more likely to experience an expansion of several times than a stock trading at 50 times his earnings. butwhich assumes strong fundamentals.
At the same time, don’t assume that a company trading at a higher multiple has less growth potential than a company trading at a lower multiple. We covered this interesting psychological barrier in our 52-Week High Tour. Keep in mind that you should look for companies that are making new highs, probably because they are likely experiencing rapid growth. And for good reason.
There are many complex calculations to justify this approach. For example, the price-to-earnings ratio (PEG), which states that the faster a company grows, the more this should affect the multiple.
But if you start with the perspective of looking for low valuations with signs of growth, you can get off to a strong start. This leads to the next step. In other words, confirmation of strong fundamentals. This boils down to two key areas.
revenue and profit growth
As emphasized earlier, revenue and profit growth show the company is on the right track.
Increased revenue means something is going well: more sales, more customers, more products. But while the signs of increased sales are good, we recommend looking for strong year-over-year growth of at least 25% per share.
Equally important, large revenue growth with revenue (profit) growth increases the likelihood of a company and its growth becoming self-sustaining. Achieving profitability means that the company may be trading at a premium relative to other slower-growing companies, but as we noted earlier, this is behind strong growth. Because it has momentum and increases in value faster.
And that momentum draws large investors into the big picture as market caps move from tiny to investable assets. Fast growing companies are more attractive and as they grow they attract more and bigger investors. I see where this is going. Smart small-cap retailers will enter first, followed by large institutions, and then everyone else if they’re lucky.
We’ve seen this many times in the past. For example, Boyd Group, Constellation Software, Monster Beverage, Xpel, and most recently his current Nanocap favorite, Inventronics, is one.
BOYD Group Service (TSX: BYD)
Constellation Software (TSX: CSU)
Monster Beverage (NASDAQ: MNST)
Xpel (NASDAQ: XPEL)
Inventronics (TSX:V:IVX)
Ignored Sector
Although less important than revenue and profit growth, looking at neglected and undervalued sectors is also a smart move. There is a saying that the last bull market leader is not the next bull market leader, but there are many signs that this is the case.
Technology isn’t in favor right now, but there’s a growing interest in the boring stuff that no one thinks about: companies doing blue-collar trading. Think cardboard boxes, rubber products, metal gimmicks, and anything else that might hurt your foot. Companies that manufacture products for power grids and telecommunications equipment are also doing very well.
Not only are many of these companies trading at very low multiples, but they are also mostly at Local company.
take action
With this knowledge, you are in a great position to act and find undervalued small caps with extraordinary potential.
Negative sentiment remains strong, reflecting global uncertainty and the corresponding cheap money threshold. While many sectors are well off the highs they experienced a few years ago, we’re also seeing a trend reversal with small caps showing great value and with great potential for multiple expansions.
In fact, we may be able to look back on the current situation as a dream scenario. Buy high-growth companies at amazing prices. Some companies are trading below net worth. The trick is to look for high-growth, low-value companies that embrace negative emotions, act against them, and struggle to keep a low profile.
Sticking to this methodology greatly increases your chances of finding the next 100 baggers. It really happens, especially in the small-cap space, and it often starts with the kind of situation we’re seeing right now. These companies are too small for sophisticated investors and institutions, but are perfect for small investors. And finally, big companies recognize growth, creating a market capitalization hurdle that triggers multiple expansions.
They’re pre-Google, small and unknown, but they don’t always last long.