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10 Small-Cap Stocks to Buy for Big-Time Growth Potential

Some might see small-caps as too risky, but these small-cap stocks to buy have significant growth potential

By Vince Martin, InvestorPlace Contributor

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The concern about investing in growth stocks usually comes down to valuation. Particularly in a market near all-time highs, stocks with significant growth potential usually have a multiple to match.

10 Small-Cap Stocks to Buy for Big-Time Growth Potential
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One way around that problem is to look at small-cap stocks to buy, where the growth stories may not be quite as well known, and the valuations may not be quite as stretched. In some cases, small-cap stocks offer more risk, but in most cases, they offer more potential rewards.

Here are 10 small-cap stocks to buy because of their significant growth opportunities and valuations that offer some upside if those opportunities are captured.

Small-Cap Stocks to Buy: AppFolio (APPF)

AppFolio Inc (NASDAQ:APPF) offers the best, and worst, of small-cap growth investing. On the positive side, revenue from AppFolio’s software for property managers is growing nicely. Sales rose more than 40% in 2016 and are guided up more than 30% this year.

The primary concern here is valuation. APPF trades at over 12x revenue on an enterprise basis. That’s a big number in any market. It’s also a notable premium to its closest peer, RealPage Inc (NASDAQ:RP).

Still, there’s reason to see more upside, even for a stock that has gained 167% over the past year. AppFolio has turned profitable this year, and margins should expand significantly going forward. The company’s MyCase software for law offices offers another growth driver for AppFolio sales. Both software products drive exactly the kind of “sticky,” recurring revenue investors are looking for in the software space.

Again, valuation isn’t perfect. But with earnings-per-share likely to clear $1 by the end of the decade, it’s not quite as extreme as headline multiples would suggest. With AppFolio’s growth prospects and potential as a takeout target, there’s likely still some room left in the APPF rally.

Small-Cap Stocks to Buy: Blue Buffalo (BUFF)

Small-Cap Stocks to Buy: Blue Buffalo (BUFF)
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Blue Buffalo Pet Products Inc (NASDAQ:BUFF) seems to have done pretty much everything right since its 2015 IPO. Revenue is growing and a new facility has improved its gross margin, leading to steady earnings expansion over the past two years.

Yet BUFF stock hasn’t quite gotten credit for that execution — even with a 35% run in the stock since early August. BUFF still trades barely above its post-IPO levels, despite solid growth in both sales and earnings over the past two-plus years.

That will likely change going forward. Blue Buffalo has a large opportunity as the leader in the “natural” pet food space. Distribution wins in e-commerce, which already drives an impressive 20% of BUFF sales — per the Q2 conference call — and at veterinary clinics. Furthermore, its market share gains, should also keep the top line growing for years to come, despite modest overall industry growth.

That has certainly been the case lately: Blue Buffalo is guiding for 9% revenue growth this year, along with a 17% increase in EPS. That’s on top of a 12% top-line improvement last year, which drove 27% growth in EPS. A new manufacturing facility should help gross margins going forward, and operating leverage will amplify further revenue increases.

Meanwhile, at 31x the midpoint of EPS, BUFF isn’t priced like a company that has the potential to dominate its category. That will likely change, and BUFF will gain as a result.

Small-Cap Stocks to Buy: Chegg Inc (CHGG)

Chegg Inc (NYSE:CHGG) has transformed itself over the past few years.

What was formerly a company focused largely on a money-losing textbook rental business has become the go-to platform for college students in the U.S. Chegg offers a wide variety of services to students, ranging from tutoring and online study help to eTextbooks and its legacy print textbook rental business (which is now outsourced, providing a major boost to Chegg profits).

Like most stocks on this list, CHGG isn’t cheap, trading at over 35x adjusted EBITDA and in the range of 70x free cash flow. But with the company guiding for 30% growth in its services business and 25% EBITDA margins overall, there’s enough to support a premium valuation.

With Chegg increasingly looking dominant in what its CEO Dan Rosensweig has called “winner take most” markets, a takeover looks likely. Amazon.com, Inc. (NASDAQ:AMZN) has tried to attract college students by building out physical bookstores and offering free Prime memberships. Chegg, which reaches the majority of those students, would give the company both an entry into that market and a wealth of valuable data to boot.

Even if Amazon doesn’t come calling, Chegg’s expanding service offerings and potential to target high school and graduate students suggest years of growth ahead. And even the current, somewhat pricey, valuation doesn’t account for all of that potential.

Small-Cap Stocks to Buy: Varonis Systems (VRNS)

Small-Cap Stocks to Buy: Varonis Systems (VRNS)
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Varonis Systems Inc (NASDAQ:VRNS) has an intriguing growth story. The company develops software for businesses that manages what it calls “unstructured data.” That includes everything from emails to spreadsheets to memos.

That data is growing exponentially — and so is the risk it poses. As seen in leaks at Sony Corp (ADR) (NYSE:SNE) and elsewhere, there’s a lot of valuable information contained in those files. Varonis protects them from unwanted entry and it organizes them for corporate managers.

The importance of unstructured data continues to drive Varonis revenue higher, with the company guiding for 25-26% top-line growth in 2017. Sales cycles remain relatively long and intensive, as in many cases Varonis still has to prove the usefulness of the software. That’s particularly true for companies who haven’t had a data breach … yet. As awareness increases and those cycles shorten, both revenue growth and operating margins will benefit.

Meanwhile, VRNS is turning profitable this year, at least on an adjusted basis. And yet it trades at a bit over 5x 2017 revenue guidance, plus cash. That sounds like a big multiple, but it’s actually somewhat modest in the SaaS space, particularly given Varonis’ growth profile.

As sales grow, and that multiple expands, VRNS should continue to climb.

Small-Cap Stocks to Buy: Ollie’s Bargain Outlet (OLLI)

Small-Cap Stocks to Buy: Ollie's Bargain Outlet (OLLI)
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There are very few retail growth stories in the U.S. of any size, particularly in brick-and-mortar retail. But Ollie’s Bargain Outlet Holdings Inc (NASDAQ:OLLI) is one to keep an eye on.

Ollie’s benefits from being in the off-price channel, one of the few areas of retail that has held up well amid the pressure from online retailers like Amazon. And while Ollie’s is much smaller than peers TJX Companies Inc (NYSE:TJX) and Ross Stores, Inc. (NASDAQ:ROST), in this case that’s a good thing.

Ollie’s just opened its 250th store;, but management sees a path to 950 locations, nearly 4x the current count. That alone suggests years of growth ahead, with strong same-store sales contributing as well. OLLI isn’t necessarily cheap, trading at 31x FY18 EPS estimates. But the company is solidly profitable, has no debt, and has that significant whitespace to build out its store count – and revenue. For investors who believe the off-price channel should continue to manage online competition, OLLI is an extremely intriguing choice.

Small-Cap Stocks to Buy: Shotspotter (SSTI)

Small-Cap Stocks to Buy: Shotspotter (SSTI)
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Shotspotter Inc (NASDAQ:SSTI) is a classic early-stage growth company. Shotspotter is unprofitable, and it will likely be so for some time as it invests for growth.

The company’s namesake product detects gunfire and notifies law enforcement in real time, making police response more efficient and neighborhoods safer. The product already has been deployed in major cities like Chicago and New York, with seven new cities adopting the software just last month.

That growth should continue, as Shotspotter brings on additional municipalities and, eventually, expands internationally as well. Revenue is still relatively small — just $19 million over the past few quarters — but a $140 million market cap leaves room for upside.

Continued adoption would make SSTI a likely takeover target for defense companies like Lockheed Martin Corporation (NYSE:LMT) or Northrop Grumman Corporation (NYSE:NOC) or other larger, government-focused suppliers. And with the need for Shotspotter unfortunately rising every year, that increased adoption seems likely.

Small-Cap Stocks to Buy: LogMeIn (LOGM)

Small-Cap Stocks to Buy: LogMeIn (LOGM)
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Video conferencing leader LogMeIn Inc (NASDAQ:LOGM) offers a nice combination of growth and value.

Recent results have been inflated by the company’s acquisition of the GoTo business formerly operated by Citrix Systems, Inc. (NASDAQ:CTXS). But even after that purchase is lapped next February, LOGM management still sees double-digit growth going forward.

But at just 24x analyst EPS estimates for EPS, LOGM certainly doesn’t look like it’s pricing in that type of growth, or — considering 35% EBITDA margins — all that much revenue growth at all. With video conferencing demand still increasing, synergies from the Citrix purchase still on the way and top-line growth, LogMeIn should be able to drive double-digit EPS growth for years to come. That in turn suggests a fair amount of upside from current levels.

There are some risks, specifically around competition, and resistance for LOGM stock has held around $120, just above current levels. But from a long-term perspective, LogMeIn still seems to have years of growth in front of it and it’s at a price worth paying.

Small-Cap Stocks to Buy: Mazor Robotics (MZOR)

Mazor Robotics Ltd – ADR (NASDAQ:MZOR) might be the riskiest stock on this list. The $1.4 billion Israeli-based company isn’t profitable, yet. Trailing twelve-month revenue is under $50 million, implying a roughly 25x enterprise value to sales multiple. And the stock has risen nearly 150% just since March.

But the company’s surgical systems for brain and spine surgery are gaining acceptance. Mazor recently pre-announced expected record revenue for the third quarter, driven by sales in both the U.S. and China. And the company is backed by Medtronic plc. Ordinary Shares (NYSE:MDT), who very well could wind up acquiring Mazor if sales continue to grow.

Again, this is a high-risk play by any measure. Mazor trades much more like a biotech stock than a medical devices manufacturer at this point. But there is huge potential reward here as well, as investors in Intuitive Surgical, Inc. (NASDAQ:ISRG) can attest. Mazor may not be the next ISRG, but it doesn’t have to be to provide strong returns, even after a sizzling performance so far in 2017.

Small-Cap Stocks to Buy: Shake Shack (SHAK)

Shake Shack Inc (NYSE:SHAK) admittedly has been a disappointment since its widely covered IPO in early 2015. SHAK shares opened their first day of trading at $47, and would eventually hit $90 in May; however, at $33 trade, they’ve since fallen sharply, not far from an all-time low.

But while Shake Shack hasn’t met expectations, it is growing. Revenue grew 37% in the second quarter, and operating profit rose 31%. Same-store sales have disappointed, and are expected to decline this year. But the company still has plenty of room to expand, and it recently announced its first location in mainland China.

SHAK is a bit of a turnaround play, but while investors seem to have moved on from the Shake Shack story, that story is still playing out. If the company can stabilize same-restaurant sales, location growth alone should drive profits — and SHAK stock — higher.

Small-Cap Stocks to Buy: iRobot (IRBT)

Small-Cap Stocks to Buy: iRobot (IRBT)
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iRobot Corporation (NASDAQ:IRBT) got a bit ahead of itself earlier this year. In mid-February, IRBT stock traded around $52; by late July, the stock had more than doubled.

IRBT has pulled back about 30% since then, driven in part by a short thesis based on competition from privately held SharkNinja. But as InvestorPlace contributor Luke Lango argued last month, IRBT looks poised for a rebound. Gross margins have expanded, the category itself is growing double-digits, and Internet of Things catalysts could further drive product adoption.

Even after the recent decline, IRBT shares aren’t necessarily cheap. But at 29x next year’s earnings, IRBT is already pricing in some level of decelerating growth. With the company capable of driving 20%+ EPS growth going forward, that multiple looks too low. And it means that IRBT’s recent declines should reverse relatively soon.

As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/10/10-small-cap-stocks-to-buy-for-big-time-growth-potential/.

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