How I’d invest $10,000 in small caps today

It’s been proven many times that most investors have the unfortunate habit of under-performing the index that they are trying to beat. Sometimes this is because of bad investment choices, other times it’s because of trading fees.

The best way to beat the market is to invest for the long-term, for at least five years if not 10 or 20 years. If you can pick a share that’s going to grow and compound over the next decade then investing becomes pretty simple.

I think small caps are the way to go because it’s much easier to grow a business’ profit from $10 million to $20 million than it is to go from $1 billion to $2 billion. They have much bigger growth potential.

If I had $10,000 to invest in small caps today, these are the ones I’d choose:

Zenitas Healthcare Ltd (ASX: ZNT) – $3,500

Zenitas is a small cap healthcare operator that provides primary care, allied care and home care. I’m quite bullish on aged-care related businesses in general because of Australia’s ageing population.

Just today the company confirmed that it’s on track to reach earnings before interest, tax, depreciation and amortisation (EBITDA) of $13 million to $15 million before acquisitions. It also announced it is going to acquire Orion Services, a disability care provider in Western Australia, for $3.6 million using the company’s cash reserves. It’s also acquiring a medical clinic in Perth for $1.8 million.

I believe Zenitas’ strategy of making bolt-on acquisitions to expand its national network will pay off as it becomes a larger player in the market.

Propel Funeral Partners Ltd (ASX: PFP) – $2,500

Propel is the second largest funeral operator in Australia, its main competitor is InvoCare Limited (ASX: IVC). There has been a lot of worry about price competition in recent months, people have been making the comparison to the UK market where a major funeral operator had to reduce prices. So far, there appears to be no danger of that in Australia.

On the face of it, it seems like Propel has a strong tailwind with death volumes expected to grow by 1.4% per annum between 2016 to 2025 and then increase by 2.2% per annum from 2025 to 2050. If Propel can grow revenue per funeral plus receive more funerals each year it should be a slow-and-steady winner.

National Veterinary Care Ltd (ASX: NVL) – $4,000

National Vet Care is the second largest veterinary clinic business in Australia and New Zealand, behind Greencross Limited (ASX: GXL).

I like National Vet Care because it offers shareholders a fairly defensive earnings profile because pet owners love their pets almost like children and will spend a lot to keep their pet alive and healthy. This includes an annual check up, with around three quarters of dogs and two thirds of cats going to the vet each year, that’s a nice source of recurring revenue.

National Vet Care achieved organic revenue growth of 3% in its latest report and is using an acquisition strategy to rapidly expand its network. Management have a loose aim of acquiring six vet clinics per year, but it’s growing at a much faster rate than this at the moment.

Foolish takeaway

I like all three of these small caps, that’s why I already own shares of all three. I’d buy more because they’re all trading at better value than a few months ago yet they have all posted growth in the most recent report. In 10 years time they could be much bigger businesses. At the current prices I’d go for National Vet Care.

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Motley Fool contributor Tristan Harrison owns shares of Greencross Limited, InvoCare Limited, NATVETCARE FPO, Propel Funeral Partners Ltd, and Zenitas Healthcare Ltd. The Motley Fool Australia owns shares of and has recommended Greencross Limited. The Motley Fool Australia owns shares of NATVETCARE FPO. The Motley Fool Australia has recommended Zenitas Healthcare Ltd. 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 Scott Phillips.

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