The small cap area of the market is the most exciting part in my opinion. Small caps may seem riskier to most people, but I think they offer investors better potential returns.
Most people think of shares as being high risk, high reward options. But, I think some shares can offer lower risk but still have potentially high rewards.
Small businesses can offer better returns because a business can grow its profit easier from $10 million to $20 million than it would be to grow from $1 billion to $2 billion.
With that in mind, here are two small caps that are in my portfolio:
Propel Funeral Partners Ltd (ASX: PFP)
Propel is Australia and New Zealand's second largest funeral operator. It has a market share of around 4.1% in Australia and 6.7% in New Zealand according to Propel's estimates.
As morbid as the funeral industry sounds, I think it has a good future because death volumes are expected to grow by 1.4% per annum between 2016 to 2025 and then increase by 2.2% per annum from 2025 to 2050 due to the ageing population. This should be a good tailwind for Propel.
Its share price has fallen in recent weeks in part due to InvoCare Limited's (ASX: IVC) weakness. However, Propel isn't making a company-wide investment in its locations, meaning Propel's earnings should grow this year. It plans to make more acquisitions in time to grow its geographical reach, such as the recent Norwood Park investment.
National Veterinary Care Ltd (ASX: NVL)
National Veterinary Care has rapidly become the second largest veterinary clinic operator in Australia and New Zealand. It was started by a few ex Greencross Limited (ASX: GXL) management who didn't like the retail addition to the business.
National Vet Care has done well since it listed and has grown its number of clinics to be in the 60s. The company could at least double the number of clinics and have less clinics than Greencross currently has.
I like the company's annual pet wellness program, which ensures pet owners bring their pets to the vet once a year and also could lead to higher revenue if any issues are found. Around two thirds of cats and three quarters of dogs visit the vet each year, which is good recurring revenue for National Vet Care.
As long as National Vet Care's balance sheet remains reasonably conservative and it can achieve organic same-clinic growth and higher profit margins then it should do well for shareholders.
Foolish takeaway
I'd be interested in buying more shares of both small caps at the current prices, due to the price declines over the past few weeks. Of course, it must be noted that small caps are generally much more volatile than large caps – so in a downturn their share prices may be hurt harder, even if the underlying performance of the business isn't damaged as much.
