In the share market risk and return are positively correlated as the more risk you take, the higher the potential return.
Small cap shares can provide investors huge returns, but the catch is that for every big winner there are dozens of losers. If you buy a small cap share and it loses half its value you have to make 100% back to just break even on your investment.
On the other hand if you pick a winner where a company grows profits and other key operating metrics strongly you can double your money in periods around one year or so.
Small caps are not 'set and forget' type investments though, as just one market update can see them rise or fall by huge amounts and potentially make or break an investing thesis.
Therefore you should only buy small caps if you spend a decent amount of time covering your own investments, or are confident in financial advice you're receiving from a full service broker for example.
Keeping in the mind the risks and rewards, let's take a brief look at three small caps that are hot right now.
Volpara Health Technologies Ltd (ASX: VHT) is a software-as-a-service medical imaging business I first covered during its April 2016 initial public offering at 50 cents per share. Shares change hands for $1.97 today as Volpara's breast cancer screening software systems grow sales in U.S. markets. It's still loss making and reported just NZ$15.7 million annualised recurring revenue as at September 30 2019. It has NZ$40 million cash on hand to grow sales and fund its goal to turn profitable.
PointsBet Holdings Ltd (ASX: PBH) is exciting investors primarily due to claims it can profit from the deregulation of U.S. sports betting markets. A May 2018 U.S. Supreme Court ruling threw out a law barring state-permitted sports gambling and the market is now developing rapidly.
PointBet is already a significant player in Australia and the vast U.S. market also offers the opportunity to capitalise on the growing rise of online and mobile sports betting. The company just raised $122 million to fund its growth push.
Audinate Group Ltd (ASX: AD8) is a hardware and software provider that allows professional audio equipment (speakers, mixers, mics, etc) to carry audio signals over a computer network, rather than using analog cables. It made a profit of $662,000 on revenue of $28.3 million over fiscal 2019. Sales are growing strongly and it appears to be a market leader well positioned for the digital future.
Foolish takeaway
All three of these businesses have tipped the hat to shareholders to raise much more money in 2019. This is no surprise given the fast-rising share prices and fact that share markets exist so companies can raise capital in exchange for offering ownership interests to investors.
All three businesses look high-risk to me given existing valuations, although that's not to say they cannot produce strong returns going forward.
