There’s a simple fact in investing that’s been proven by years’ worth of data. Small-cap stocks beat larger ones. Starting with economists Eugene Fama and Kenneth French’s landmark paper — The Cross-Section of Expected Stock Returns — we’ve realized that small-cap stocks have been the place to find great long-term returns. And the reasons for their outperformance are easy to understand.
For one thing, it’s a lot easier for a small-cap stock to grow and double in size than say a firm with a trillion-dollar market capitalization like Microsoft (NASDAQ:MSFT). Secondly, there’s sort of an acquisition premium placed on smaller firms. Again, there’s zero chance that MSFT gets bought out. The combination of these factors has produced some stellar returns for small-cap stocks over the decades. In fact, looking at Fama and French’s study, small-cap stocks have managed to outperform larger ones by roughly 3% per year all the way back to the 1920’s.
For investors — especially younger ones — looking to grow their portfolios, small-caps stocks are the ones to buy.
And with the Russell 2000 starting to perk-up over the last few months, small-cap stocks’ dominance over larger ones is almost assured. With that, the time to keep over-weighting smaller firms is now. Which small-cap stocks should you buy? Here’s three that make great portfolio additions.
Small-Cap Stocks to Buy: Boston Beer Company (SAM)
Boston Beer Company (NYSE:SAM) is a prime example of how small-cap stocks aren’t always unknown firms. Its Samuel Adams beer brand is pretty well known at this point and has helped turn SAM into one of the largest “craft” brewers in the nation — with its namesake beer helping the firm pull in more than $348 million in sales last quarter. What’s impressive for SAM is that sales jumped more than 23% year-over-year.
The reason for that jump has been SAM’s constant innovation and penetration into new markets. As consumer tastes have changed, SAM has changed with them. With hard cider and spiked seltzers now ruling the roost, Boston Beer unveiled the Angry Orchard and Truly brands. Those brands have become barroom staples — with Truly generating triple-digit volume growth. Secondly, Sam Adams has been seen as one of the “gateway drugs” to better craft beer. It’s recent buyout of brewer Dogfish Head has provided SAM with the next stage of a beer drinker’s evolution. The end result is some pretty torrid growth for the beverage marker.
And investors have taken notice. SAM stock has surged more than 36% this year.
Now, because of that surge, SAM stock isn’t the cheapest with a forward price-to-earnings ratio near 40. But there is still growth to be had. And longer term, Boston Beer still has some levers to pull to keep the growth going. In the end, SAM is one of the more exciting small-cap stocks to buy for long-term investors.
Teladoc (TDOC)
Thirty-five bucks. That’s all it costs to use Teladoc’s (NYSE:TDOC) services to diagnose an ear inflection for my 5-year old child. Previous physical visits to our doctor’s office for the same thing were closer to $165. And that’s with good health insurance. My personal experience highlights the power in TDOC’s platform.
It’s no secret that healthcare costs are exploding and much of the pending regulation is focused on reducing those costs. This is exactly the sandbox in which TDOC plays. The firm is the largest player in the growing telemedicine field. Here, patients can fire up their tablets, PCs or smartphones and speak to a physician in real time, get a diagnosis and even send a prescription to their local pharmacy. The best part — as highlighted above — is there is a real cost savings for consumers. That cost savings for basic health needs is a real win and many health insurers, benefit managers and employers have added TDOC to their benefits packages.
Consumers are using it as well. Last quarter, Teladoc saw a 55% year-over-year jump in memberships and 45% jump in number of visits. This helped TDOC also see a big 24% year-over-year revenue boost. With new growth avenues such as mental health services ramping up, there’s plenty of runway left for the stock.
For investors, TDOC could be one of the best small-cap stocks to buy for the shift in how we consume healthcare.
Texas Roadhouse (TXRH)
One of the most fertile areas for small-cap stocks is in the consumer discretionary sector. There are plenty to chose from. However, the key here is to find those with strong brand names and real consumer loyalty. Texas Roadhouse (NASDAQ:TXRH) could just be such a small-cap stock. When fans create a whole meme subculture around your dinner rolls, you must be doing something right.
TXRH operates over 580 restaurants system-wide across 49 states and nine foreign countries. And those restaurants are pretty successful. Texas Roadhouse has been able to make some big bank on America’s consumer story. Sales continue to grow across its system as has average check size. This has helped boost margins at the firm. The best part for TXRH is its overall niche. It’s generally lower prices for a dinner make it sort of immune to real downturns in consumer spending. Add in its cult-like status among fans, and you have a recipe for success.
The chain continues to find news way to grow as well. This includes the launch of its new sports bar themed Bubba’s 33. CEO Wayne Kent Taylor during the company’s last earnings call showed that initial results for the 20 Bubba’s restaurants were great with comparable-store sales growing by 6.3%. Those results were good enough that TXRH has plans to keep the expansion going for the chain concept.
Investors may want to buy TXRH stock for another reason as well. We’re talking dividends. Many small-cap stocks are good dividend payers thanks to their high founding and insider ownership structures. Texas Roadhouse is a prime example of that. The stock currently pays 2.1% and has grown that payout annually.
At the time of writing, Aaron Levitt did not have a position in any of the stocks mentioned.
