The stock market slid into year-end and started 2019 off in selloff mode, and leading the decline were small-cap stocks. While the major indices were all off 10% to 15% from their recent highs in December, the Russell 2000 small-cap benchmark had hit bear market territory. That means small-cap stocks gave back more than 20% off their recent highs. With the small-cap index rebounding in 2019, is it reasonable to expect such volatility over the next 12 months?
Sure, December saw a big drop … but it wasn’t anything unusual. Small-cap stocks tend to drop big when the markets are turbulent. Back in 2015-2016, the S&P 500 dropped about 15% off recent highs. The Russell 2000 dropped more than 25%. Back in 2011-2012, the S&P 500 corrected less than 20% lower. The Russell 2000 dropped about 25%. In fact, during almost every market downturn over the past twenty years, the Russell 2000 has been hit harder than the S&P.
But there’s a flip-side to this narrative. When the market turns around, the Russell 2000 leads the way.
Following the 2015-2016 correction, small-cap stocks rallied more than 40% over the following year, versus a sub-25% gain for the S&P 500. Following the 2011-2012 correction, same story. Small caps rallied 40% over the following the year. The S&P 500 added about 30%. Lather, rinse, repeat for every major rebound in recent memory.
As such, history says that as market selloffs turn around, small-cap stocks lead the rally.
Which small caps will be at the front of this charge? Let’s take a deeper look at five small-cap stocks with big growth potential in 2019.
Market Cap: $3.3 billion
Big Idea: The digital revolution is finally hitting the education space, and Chegg (NASDAQ:CHGG) is pioneering a potentially immensely valuable connected learning market.
Digital education platform Chegg has been a big-time winner over the past few years. During that stretch, Chegg has pivoted from textbook rental company to student-first connected learning platform that high school and college students across America are increasingly using as a digital education assistant. This transition has powered huge revenue growth, huge margin expansion, and huge profit growth, the sum of which has pushed CHGG stock more than 300% higher over the past three years.
This transition is set to continue. Chegg only has 2.2 million subscribers. There are 36 million high school and college students across America alone. At scale, Chegg should be able to capture at least half, if not more, of that market. Plus, there is a huge international opportunity for this company which still remains untouched.
Overall, this is a high-margin, big-growth company attacking a rapidly evolving digital education market. That combo implies big-time growth potential in the long run.
Market Cap: $2.3 billion
Big Idea: The robots are here, and through its suite of robotic vacuum cleaners and mops, iRobot (NASDAQ:IRBT) is at the forefront of what promises to be a huge global households robotics market.
At the current moment, the iRobot growth narrative is all about robotic vacuum cleaners. The company’s core product, Roomba, has morphed into the runaway leader in this secular growth market. Sales are up big despite worries over a niche market. Margins are up big despite elevated competition. And, profits are up big, and that has powered a strong rally in IRBT stock.
But, the next leg of growth here isn’t all about robotic vacuum cleaners. It’s about the entire household robotics space. As the consumer and innovation leader in the robotic vacuum market, iRobot is well positioned to be the leader in other household robotics markets, like robotic lawnmowers, robotic glass cleaners, robotic drink makers, so on and so forth.
From this perspective, iRobot is just scratching the surface of its long term potential, meaning this stock has lot of runway let over the next several years.
Market Cap: $1.9 billion
Big Idea: The subscription economy has arrived, and as enterprises of all shapes and sizes pivot to a subscription model, they are turning toward Zuora (NYSE:ZUO) for help.
Say hello to the subscription economy. Over the past few years, the market has figured out that everyone loves subscriptions. Sellers love subscriptions because they lend themselves to higher profitability and greater predictability. Buyers love subscriptions because they are convenient, feel cheaper than one-off purchases and also allow for greater predictability. As such, because both sellers and buyers love subscriptions, enterprises of all shapes and sizes are pivoting to subscription models.
At the core of the subscription economy is little-known Zuora. Zuora is essentially the company that makes the software which allows enterprises to build a subscription business. In this sense, Zuora provides the building blocks for the subscription economy. The company counts ~1,000 customers that include some huge names like TripAdvisor (NADSAQ:TRIP), Delta (NYSE:DAL), FedEx (NYSE:FDX), and Nvidia (NASDAQ:NVDA).
When you think about how big this company could get, the upside is enormous. Zuora currently has less than a $2 billion market cap. But, the company provides the building blocks for what could become the norm across the entire multi-trillion dollar global economy within the next decade. From this perspective, long term upside is compelling.
Market Cap: $2.6 billion
Big Idea: The digital revolution is just beginning its crusade through the law enforcement world, and Axon (NASDAQ:AAXN) is the unparalleled leader in this rapidly growing space.
Law enforcement agencies globally are in need of a digital makeover. Axon is providing that digital makeover through various hardware and software products, including smart weapons, body cameras, dash cameras, cloud software, and records and data management solutions. Importantly, these solutions are all about improving operational efficiency, officer accountability, and public safety, three things which are consensus long term positives.
Axon is largely without competition in this space, and the company’s reach is only growing through various new products, like a smart weapon that dials calls 911 when deployed. As such, this company’s long term growth potential is quite astounding when you consider that the U.S. alone spends about $100 billion per year on police. Axon’s chances of realizing that potential are quite high considering the mitigated competition, meaning the long-term risk/reward on AAXN stock is quite favorable.
Weight Watchers (WTW)
Market Cap: $3 billion
Big Idea: Healthy eating and fitness lifestyle trends are more prevalent today than ever before, and this is dramatically expanding the overall health and fitness market, in which Weight Watchers (NYSE:WTW) is a big player.
The bull thesis on WTW stock finds its roots in the rise of photo and video sharing apps like Instagram and Snapchat. Because everyone is sharing photos everywhere on these apps, everyone wants to look good in their shared photos, and one way of looking good is through health and fitness. As such, the rise of Instagram and Snapchat has been accompanied by a boom in the health and fitness industry.
Weight Watchers is at the heart of this boom. Not only is their greater desire among consumers to eat healthily and lead an active lifestyle, but celebrity endorsement of weight loss programs from widely followed icons such as Oprah has empowered a new generation of consumers inspired to lose weight.
These two trends won’t reverse course any time soon. Consumers are only becoming more open about weight loss, and more eager to become fit and healthy. As these two trends spread globally over the next several years, Weight Watchers’ business should grow by leaps and bounds. Right now, this is just a $3 billion company. The weight management market in the U.S. alone is expected to be in excess of $250 billion by 2024. Thus, there’s lots of room for Weight Watchers to become a much bigger and much more valuable company over the next several years.
Stitch Fix (SFIX)
Market Cap: $1.9 billion
Big Idea: Data-driven, digital, and personalized shopping is the future of commerce, and Stitch Fix (NASDAQ:SFIX) is pioneering this future, which represents a several hundred billion dollar opportunity.
The core of the SFIX bull thesis is all about digital and data. Broadly speaking, data and digital have come together across many different industries to create new products and services which are far better than their predecessors. Think Amazon (NASDAQ:AMZN), which created a data-driven digital retail platform that proved far better than traditional retail. Or, think Netflix (NASDAQ:NFLX), which created a data-driven digital entertainment platform that proved far better than traditional television. Everywhere you look, data and digital are converging to create better-than-ever solutions.
Stitch Fix is doing this with personalized shopping. They are revolutionizing the e-retail model to be more efficient through the use of data-driven and people-powered curation. This model should ultimately gain significant share over the next several years due to its cost, time, and hassle benefits. Because Stitch Fix is the leader in this space, as the personalized e-retail model gains share over the next several years, Stitch Fix will gain share, too.
The long term growth aspect is predicated on the idea that Stitch Fix is a small company (less than $2 billion market cap) attacking a huge global apparel market ($1.7 trillion). As such, there’s plenty of room for Stitch Fix to become a much bigger company than it is today, and that’s exactly what will happen so long as personalized and data-driven e-retail remains on a growth trajectory.
Market Cap: $3.4 billion
Big Idea: Just as Netflix was the centerpiece of the streaming services movement, Roku (NASDAQ:ROKU) is the centerpiece of the streaming players movement, and this movement is still in its early innings. Despite Citron’s Tweet Tuesday morning that Roku stock is “uninvestable” due to the surprise team-up between Apple (NASDAQ:AAPL) and Samsung, Roku shares are still up 16% for the week. The bullishness is due to Roku having revealed that it has 27 million active accounts with a 68% rise in time spent streaming.
There are 4 billion internet users in the world. There are 1.6 billion TV households globally. But, there are just 400 million streaming subscription subscribers in the world. While 400 million is a big number, it is pretty small next to 1.6 billion. Inevitably, because of the cost and convenience advantages of streaming over traditional TV, all 1.6 billion TV households will eventually be streamers.
At scale, that means the streaming market should quadruple over the next several years. That’s a lot of streamers. And, all those streamers won’t be on the same service. Some will have Netflix. Some will have Amazon Video. Others will have Hulu, YouTube TV, or ESPN+. A handful will have more than one.
This dynamic means that consumers need a device to stream all this content without bias, like a cable box for the streaming world. Enter Roku. Roku is already the market leader in the streaming device world with runaway 40% share. Roku is also the leader in the smart TV market with a 25% share. And, importantly, Roku is a content-agnostic curation platform, making it far more consistent and convenient than streamers from Google (NASDAQ:GOOG) and Apple (NASDAQ:AAPL), which are inherently biased.
Overall, Roku stock is positioned for explosive growth over the next several years as the streaming market becomes more crowded than ever. This growth track represents a huge opportunity. But, Roku is a small company with just a $3 billion market. As such, the potential for value creation over the next several years is quite large.
As of this writing, Luke Lango was long CHGG, NVDA, AAXN, WTW, AMZN, NFLX, GOOG and AAPL.