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How to profit from these 3 growing small caps

The larger a business is the harder it gets for it to meaningfully grow. That’s why it’s better to focus on smaller businesses if you want to try to achieve market-beating returns.

However, smaller doesn’t necessarily mean better or safer. In fact smaller businesses are probably riskier, so they deserve the appropriate scrutiny.

It seems the best types of growth businesses over the last few years are ones that can leverage software to grow their business with little to no cost. Here are three growth businesses that could produce great returns over the next few years:

Class Ltd (ASX: CL1)

Class is a cloud accounting software provider to self-managed superannuation fund (SMSF) administrators. It currently has a market capitalisation of $336 million which could grow strongly over the years ahead.

It produces a lot of efficiencies with its processes and automation which makes doing work on its platform profitable for accountants. This is one of the main reasons why Class has achieved a retention rate of over 99% over the last few years.

Class continues to benefit as the number of SMSFs moving onto the cloud grows each year. Class is currently trading at 55x FY16’s underlying earnings with a grossed-up dividend yield of 2%.

Altium Limited (ASX: ALU)

Altium is the provider of electronic PCB software which helps designers create the products of the future. Altium has grown its market capitalisation to $1 billion and there is no sign of the underlying business slowing down any time soon.

The products of today are becoming increasingly complex and need more technological input. Altium is helping organisations like NASA, CSIRO, Cochlear Limited (ASX: COH), John Deere and Toyota deliver the products of tomorrow.

Management are predicting revenue to double over the next few years. If they manage to achieve this then Altium’s share price of $7.88 today could grow significantly. Altium is currently trading at 28x FY17’s estimated earnings with an unfranked dividend yield of 2.66%

Afterpay Holdings Ltd (ASX: AFY) 

Afterpay is a provider of buy now, pay later solutions for retailers and it currently has a market capitalisation of $169 million

It recently announced it would be made available on Wesfarmers Limited’s (ASX: WES) Officeworks website. It’s also offered by a list of retailers which includes Cotton On, Telstra Corporation Ltd (ASX: TLS) and Myer Holdings Ltd (ASX: MYR).

Afterpay isn’t yet making a net profit or paying a dividend.

Foolish Takeaway

I think all three of these businesses are worth considering for your portfolio with how much they may grow over the coming years. At the current prices my order of preference would be Class, then Altium and finally Afterpay.

5 stocks under $5

We hear it over and over from investors, "I wish I had bought Altium or Afterpay when they were first recommended by The Motley Fool. I'd be sitting on a gold mine!" And it's true.

And while Altium and Afterpay have had a good run, we think these 5 other stocks are screaming buys. And you can buy them now for less than $5 a share!

*Extreme Opportunities returns as of June 5th 2020

Motley Fool contributor Tristan Harrison owns shares of Altium and Class Limited. The Motley Fool Australia owns shares of Altium and Class Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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