Small-cap stocks can produce some of the largest gains in the stock market. These stocks often fly under the radar because fewer analysts do the necessary research to find them. Furthermore, they aren’t plastered all over the news like the Magnificent Seven stocks. This has led to this list of high-risk, high-reward small-cap stocks.

Investing in small cap stocks is riskier because there’s more research involved. You won’t be able to turn to many media sources to find this information, and you will have to interpret earnings reports and stay on top of release dates. 

This line of investing can be rewarding, and you will discover three stocks that fit the category. While small cap stocks comprise of stocks with market caps between $250 million and $2 billion, this list will include a company that is well on its way to becoming a small-cap and another firm that recently graduated from the category.

Sprout Social (SPT)

Sprout Social (NASDAQ:SPT) trades at a $3.7 billion market cap and needed a rally that started in November to move out of the conventional small-cap territory. The firm is a social media management tool that helps clients schedule social media posts and build brand awareness. The firm has over 30,000 customers including large corporations and universities. Sprout Social also helps small businesses which gives it a large addressable market.

The company offers a 30-day free trial for its plans but then starts at $249/mo and builds from there. That’s a lot of recurring revenue from each customer, and the financial impact is apparent in earnings reports.

Sprout Social reported $85.5 million in revenue in the third quarter of 2023. This represents a 31% year-over-year growth rate. Annual recurring revenue came in at $359.5 million and was up by 33% year-over-year. Remaining performance obligations increased by 67% year-over-year.

Shares have jumped by 250% over the past five years but are slightly down over the past year. The major component holding SPT back from more gains is profitability. The company reported a $23 million GAAP loss in the quarter compared to a $13.9 million GAAP loss in the same time next year.

Sprout Social has done a better job in previous quarters to minimize losses and get closer to profitability. If the firm reduces losses in the next quarter, the equity is likely to rally. This makes it one of those high-risk, high-reward small-cap stocks to consider.

Direct Digital Holdings (DRCT)

Direct Digital Holdings (NASDAQ:DRCT) isn’t quite a small-cap stock, but it may have joined the class by the time you read this article. The equity has a $240 million market cap and trades at a 54 P/E ratio. However, shares trade at a more attractive 18 forward P/E ratio. Shares are up by over 500% since the start of November.

The programmatic advertising company’s Q3 2023 earnings report explains why it has attracted more investors. Revenue increased by 129% year-over-year while the company expects to deliver 101% year-over-year revenue growth for the full year. That’s an acceleration from the previous two quarters’ growth rates. 

Direct Digital Holdings makes most of its revenue from Colossus, its sell-side advertising platform. Revenue from this platform surged by 174% year-over-year while buy-side advertising revenue went up by 10% year-over-year. Luckily, more than 85% of the company’s total revenue comes from its sell-side platform.

The advertising firm’s net income more than quadrupled in this quarter. If DRCT can maintain high net income growth and get its profit margins in the double-digits, this stock can generate significant returns for long-term investors. This makes it one of those high-risk, high-reward small-cap stocks to buy.

Perion (PERI)

Perion (NASDAQ:PERI) is a small adtech company that is growing in several key advertising channels. Despite a decent earnings report, shares plunged by more than 20% on the news and have created a buying opportunity. 

This quarter featured “notable growth in Search, CTV, and Media” which resulted in a 12% year-over-year revenue increase. Two concerns with the earnings report are GAAP net income growth and a reliance on search advertising revenue.

GAAP net income growth only came in at 2% year-over-year which the company will have to fix in future quarters. Perion has been a top performer with a 694% gain over the past five years, so it is plausible that the company recovers on this front. 

Perion’s search advertising revenue grew by 33% year-over-year, but that revenue depends on a partnership with Bing. The two companies have to renew their contract in 2024 or else that revenue stream will go away. The companies have worked together for over a decade, so it’s very likely that this contract gets renewed. However, the market is keeping the stock down due to this uncertainty.

Shares trade at a very affordable 8 forward P/E ratio and a 0.35 PEG ratio. Perion stock should soar if (and likely when) a contract with Bing gets renewed this October.

On this date of publication, Marc Guberti held long positions in DRCT and PERI. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.