As companies get larger it becomes much harder for them to maintain strong earnings growth rates. This phenomenon is often referred to as the law of large numbers.
Take for example a company such as Westpac Banking Corp (ASX: WBC). Last year it produced net profit of $8 billion, taking its 10-year average earnings growth rate to a good 4.9% per annum.
Once earnings get to this level it becomes near impossible to increase them at the same rate as a smaller company. A small cap company could feasibly grow their earnings at over 20% per annum for a good number of years.
If the company can deliver this level of growth, I would expect share price gains of a similar level. Because of this, some small cap shares have a tendency to outperform their blue chip rivals.
I have picked out four small cap shares with explosive growth rates to add to your watch list today:
Catapult Group International Ltd (ASX: CAT)
Catapult Group is an exciting sports analytics company which provides sporting organisations and athletes with real time data and analytics to monitor and measure performance and injury risks. Thanks to a client list of the biggest names in sports that runs into the hundreds, analysts are expecting it to grow its earnings by nearly 43% per annum for the next couple of years.
Clearview Wealth Ltd (ASX: CVW)
This life insurance, wealth management and financial advice solutions company currently has a market capitalisation of $570 million. According to CommSec, analysts are expecting earnings to grow at an unbelievable average rate of 79% per annum through to 2018. Priced at 51 times earnings currently, the shares do not come cheap. But if it delivers on expectations, few will mind paying a premium for the shares.
Lifestyle Communities Limited (ASX: LIC)
Lifestyle Communities is a company which could profit from Australia's ageing population. It provides retirement living through over 55 villages based in Victoria. The market has high expectations for the company. It expects earnings per share of 14.3 cents in FY 2016, to grow to 22.2 cents per share in FY 2018. I believe this share is a must for watch lists.
Nextdc Ltd (ASX: NXT)
NEXTDC has data centres in five of Australia's largest cities. As more companies move to cloud-based applications I would expect demand for data storage to grow at an incredibly high rate. NEXTDC is extremely well positioned to benefit from this demand. For this reason I can understand why analysts are expecting it to grow earnings from 2.3 cents per share in FY 2016, all the way to 11.7 cents per share in FY 2018.
Foolish takeaway
Although small cap shares can produce returns that far exceed blue-chip shares, they do generally come with higher levels of risk and volatility. Growth shares are often priced on high multiples because the market expects big things from them. Failure to deliver on expectations can lead them to fall out of favour and see rapid share price declines.
If it is growth you are looking for, then this company could provide even more explosive growth than these four combined!
