When you build an investment of portfolio of say 10 to 20 shares the majority of your holdings should be high-quality larger companies with blue-chip qualities, strong track records of profit growth, and superb outlooks supported by robust competitive positions.
However, for more experienced investors it’s worth taking a look at the small-cap end of the market as it’s companies with market values lower than $2 billion that have the most opportunity to produce eye-watering returns.
After all a company can go a lot faster from a $500 million company to a $5 billion company, than from a $50 billion company to a $500 billion company.
This is due to the law of large numbers and because the market values larger companies more conservatively. In other words they are unlikely to get the large valuation or profit multiple re-rating that can turbo charge a small-cap share price when delivered in conjunction with strong profit growth.
Take the US$900 billion tech giant Apple Inc. that trades on around 14x trailing earnings despite being arguably the world’s best company.
While a small-cap exhibiting signs of accelerating growth can easily have an earnings multiple up to 100x (despite having nowhere near the quality of Apple Inc) if investors believe it can double profits for a number of years in a row.
So here are three small businesses you should know about.
Pro Medicus Ltd (ASX: PME) is a software-as-a-service medical imaging business I’ve covered a lot over the last 4 years. It’s a founder-led market leader in lucrative global healthcare markets that is executing well, profitable, and boasts a strong track record of growth.
In fact it ticks all the boxes except perhaps valuation, therefore I’d rate it a hold for now. However, much cheaper, and it’s a buy.
Bigtincan Holdings Ltd (ASX: BTH) only has a $119 million market valuation, but is a software business that has partnerships with Adobe and Salesforce as the kings of online CRM systems. Bigtincan just entered a trading half to raise around $16 million to give it the balance sheet firepower to continue its organic growth push. It’s high risk, but could produce big returns.
Alteryx Inc. (AYX) is a founder-led NASDAQ listed U.S. data analytics company that is forecasting a profit in 2019 and is growing like nuts. I’m flagging it because it has a significant presence in Australia with customers like Commonwealth Bank of Australia (ASX: CBA), Telstra (ASX: TLS), the NBN Company and Australia Post.
It also has a blue-chip client list in the U.S. subscribing to its data-crunching platforms, which suggests its tech provides a moat or competitive advantage that bodes well for the future. The stock has run hot, but I’d rate this US$5 billion business a buy today.
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Tom Richardson owns shares of Alteryx, Apple and Pro Medicus Ltd.
You can find Tom on Twitter @tommyr345
The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Pro Medicus Ltd. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of BIGTINCAN FPO. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia has recommended BIGTINCAN FPO and Pro Medicus 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.