Major League Baseball’s Home Run Derby offered an important lesson for investors in small-cap stocks: When swinging for the fences, even the most towering blast off the fattest cookie of a pitch can still come down on the warning track.
And so has it been with shares in MAKO Surgical (NASDAQ:MAKO), which plunged 40% in early Tuesday trading after the maker of robots to assist in knee replacements cut its sales forecast.
As recently as March, MAKO was a small-cap stock on the make. Shares were up 78% in the first three months of the year, and it was easy to see why MAKO made InvestorPlace‘s list of the 10 Best Stocks for 2012.
But shares have cratered nearly 70% since then, clobbered first in May when MAKO said it would sell fewer robotic surgery systems, and then again Tuesday when it cut its sales forecast for the second time in as many months.
In the process, Mako has gone from a small-cap with a market value of nearly $2 billion to a micro-cap of just $630 million. With the shares in freefall, making a bet at this point looks like trying to catch a falling scalpel.
That’s the conundrum of small-cap stocks. On the one hand, they often offer the most outsized growth prospects and best value propositions. Small caps can increase sales, earnings and share prices exponentially because they start from such a small base. After all, it’s a heckuva lot easier to double sales from, say, $1 million to $2 million than from $100 billion to $200 billion.
And, because they don’t get much analyst or market coverage, small-caps often can be mispriced in your favor.
However, small-caps, by definition, have much smaller floats and thinner trading volume, making them much more volatile. That leaves them far more susceptible to big drops on bad news.
It also doesn’t help that they’re often one-trick ponies. Smaller companies tend to have more concentrated revenue streams. If something goes wrong with the main (or only) business line, it can kill the entire bottom line.
Consider MAKO, which saw its stock plunge Tuesday in part because it sold nine surgical systems in the latest quarter when analysts were forecasting it would sell 11.
That’s right: You can count the company’s quarterly unit sales on two hands — and you can count the sales unit miss on two fingers. Small company, little room for error.
Yes, at some point the selloff likely will be overdone, if only because MAKO does offer a valuable product in a burgeoning industry. There are roughly 80 million baby boomers heading into a time of life when knees and hips start to go. The answer to such decrepitude has been total joint replacement — a major surgery done more than 800,000 times a year in the U.S., requiring months of recovery.
MAKO, however, offers an alternative that resurfaces rather than replaces joints. That gets patients back on their feet in a day and doing normal activities in as little as a few weeks.
Sounds like a no-brainer of a bet. But as so often happens in high-risk small caps, a great product in a great market doesn’t automatically equal great profits — or share-price performance.
At least not without some serious stumbles along the way.
As of this writing, Dan Burrows did not hold a position in any of the aforementioned securities.