Editor’s note: This story was previously published in October 2017. It has since been updated and republished.
The concern about investing in growth stocks usually comes down to valuation. Stocks with significant growth potential usually have a multiple to match. One way around that problem is to invest in small-cap stocks, 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 come with more risk; but in most cases, small caps offer more potential rewards.
Here are eight small-cap stocks to buy due to significant growth opportunities. Each of these small-cap companies have valuations that lend themselves to significant upside if those opportunities are captured.
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. The company’s total revenue jumped about 40% last year
The primary concern here is valuation. APPF trades at over 17 tines 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. AppFolio has turned profitable, and its 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 75 cents 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.
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 14 times its revenue and a forward price-earnings ratio of about 52. But with the company’s earnings per share expected to nearly double this year, 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.
Varonis Systems (VRNS)
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’s 2018 top-line growth expected to come in at about 20%. 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 expected to report a profit for 2019. And yet it trades at a bit over 14 times its trailing-twelve-month revenue, 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.
Ollie’s Bargain Outlet (OLLI)
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.
The company’s store expansion plan alone suggests years of growth ahead, with strong same-store sales contributing as well. OLLI isn’t necessarily cheap, trading at 33 times analysts’ consensus FY19 EPS estimate.
But the company is solidly profitable, has little debt, and has 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.
Shotspotter Inc (NASDAQ:SSTI) is a classic early-stage growth company. Shotspotter is expected to become profitable for the first time this year.
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 $34 million over the past year — but a $491 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.
Video-conferencing leader LogMeIn Inc (NASDAQ:LOGM) offers a nice combination of growth and value.
Trading at just 15 times analysts’ consensus EPS estimate, LOGM certainly doesn’t look like it’s pricing in the huge EPS growth analysts are expecting this year. With video conferencing demand still increasing and top-line growth expected in 2019, 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. But from a long-term perspective, LogMeIn still seems to have years of growth in front of it and it’s trading at a price worth paying.
Shake Shack (SHAK)
Shake Shack Inc (NYSE:SHAK) is growing. Revenue is expected to jump 28% this year. And the company still has plenty of room to expand, and it recently opened its first restaurant in mainland China.
SHAK is a bit of a turnaround play, but the Shake Shack story is still playing out. If the company can stabilize same-restaurant sales, location growth alone should drive profits — and SHAK stock — higher.
iRobot Corporation (NASDAQ:IRBT) got a bit ahead of itself last year. In April, IRBT stock traded around $60; by late August, the stock had nearly doubled.
IRBT then pulled back over 30%, subsequently rebounded back near its former highs, and then dropped again. But the category itself is growing double-digits, and Internet of Things catalysts could further drive product adoption.
IRBT shares aren’t necessarily cheap. But at 24 times next year’s earnings, IRBT isn’t very expensive for a company in a rapidly growing category. With the company capable of driving 20%-plus EPS growth going forward, that multiple isn’t very steep.
As of this writing, Vince Martin did not hold a position in any of the aforementioned securities.