Small-cap stocks come with much higher risk and as we all know, that potentially leads to high returns. Should they not perform, a small allocation will protect you against material losses. Only a small portion of your funds should be directed toward these more speculative investments.
Here are three ideas for your portfolio.
1. 1300 Smiles (ASX: ONT)
1300 Smiles provides dental surgeries, practice management and other administrative services to self-employed dentists. It also provides general dentistry services to patients and owns and operates full-service dental facilities at 24 sites in Queensland. It belongs to a genre of companies called roll-ups, because it aims to aggregate practices to achieve economies of scale.
In a significant boost for the dental industry, more than 3 million children are now eligible for Medicare-funded dental care as of January 1, 2014. 1300 Smiles could prosper, as families receiving Family Tax Benefit Part A will be eligible for $1,000 worth of treatment over a two-year period. More upside is possible as the Greens want the scheme to extend to 3 million pensioners by 2015 and to all Australians by 2018/2019 at a full cost of $8.5 billion.
2. Paladin Energy (ASX: PDN)
Paladin is a uranium producer and explorer with projects in Australia, Canada and Africa. Its flagship project is the Langer Heinrich mine in Namibia.
In September, 2013, broker JP Morgan suggested that Paladin's days may be numbered, due to various concerns. These included extended weak uranium prices, a cash burn rate that forced an immediate cost cutting program and an onerous debt burden. The share price had fallen from above $6.00 in early 2008 to trade as low as 38 cents last November, before bouncing back to current levels of 57 cents.
However, two recent announcements suggest a turnaround may be underway. First, the refinancing of the Langer Heinrich and Kayelekera project debt facilities were successful in reducing principal repayments by US$53 million per annum. This was a testament to increasing production and falling costs at the Langer Heinrich mine. Then Paladin sold a 25% joint-venture stake in the same mine (with an associated off take agreement) to a wholly owned subsidiary of the leading Chinese nuclear utility, China National Nuclear Corporation for US$190 million.
3. Grange Resources (ASX: GRR)
Grange owns and operates an iron ore mining and pellet production business called Savage River in Tasmania. It is also looking to develop the Southdown Magnetite Project in Western Australia. On January 1, 2008, Grange was trading above $2.00, plummeted to 13.5 cents last May and is now at 25.5 cents.
Several brokers recently raised their target prices, as a result of both increasing production and a jump in the pellet premium to around US$38/tonne. Bell Potter estimates that at current forecast prices, Grange could generate free cash flow of greater than $100 million or approximately 9 cents per share in 2014. With no debt and no immediate growth plans, this could be returned to shareholders as a dividend, which is currently forecast to be 2 cents.
Foolish takeaway
There is always a place for small companies in a well-diversified portfolio. Of the three stocks, two are riskier turnaround situations. My preference is for Grange given the prevailing positive mood in the iron ore sector. The turnaround story for Paladin buys time for the company but an eventual upturn in uranium prices is required. The less risky investment is 1300 smiles, which potentially gains additional economies of scale with each dental practice acquisition.
