What investor doesn’t have a little lingering regret over a small-cap stock they didn’t buy that later went on to post massive gains?
Not all small-cap stocks become Apple; however, historically, they have outperformed large caps. According to data from Cabot Wealth, over the last 20 years, the S&P 600 Small-Cap Index has recorded an annualized return of 10.5% compared to 7.9% for large caps over the same period.
Clearly, there is value in investing in small-cap stocks, but since these companies tend to fly under the radar, knowing where to look for opportunity and then choosing the right one is easier said than done.
Fortunately, Cabot Wealth has put together a five-step guide to picking small-cap stocks.
1. Look for Opportunities where Paradigm Shifts Transforming the Existing Market
Step one, looking for paradigm shifts in the market. What exactly is a paradigm shift? A paradigm shift is a fundamental change in the way a business or industry operates. For example, mobile technology and digital wallets have led the revolution towards a cashless society, giving birth to a slew of fintech startups that moved on to become giants. Just look at PayPal and Square.
Investors should seek out these types’ paradigm shifts, looking for the so-called pioneers who are leading the charge, and then search for related companies or suppliers that stand to benefit equally from the movement. For example, when the world began transitioning from mainframe to personal computers, Cisco provided the necessary networking tools, and the stock increased over 70 times.
2. The Bigger the Potential Market, the Better the Opportunity
Small-cap stocks are inherently more risky than large caps. Investors should look for opportunities with small companies serving large, rapidly developing markets to mitigate some of that risk. Cabot analyst Tyler Laundon refers to it as The Law of Large Numbers. Even if a company only captures a small portion, the enormity of the market creates massive upside potential while reducing overall risk.
For example, Alzheimer’s is the 5th leading cause of death in adults over 65, affecting more than 5.8 million people. The cost of Alzheimer’s treatment is anticipated to climb from $305 billion in 2020 to more than a trillion by 2050.
A company capturing even a fraction of that market could present a significant opportunity for investors.
3. “Rob the Train Before it Gets to the Station” Invest in Small Companies Before Large Investors Notice
Timing is everything when it comes to investing in small-cap stocks. And getting in before mutual funds, hedge funds, and pensions drive up stock prices is crucial. By researching high-growth, newly burgeoning markets, retail investors can gain a research advantage over large institutional players and stake a position early.
Laundon likes companies with less than 50% institutional ownership, hoping to benefit from price appreciation when the big investors jump on board later.
4. A Small-Cap Stock Worth Investing in Should Offer Both Growth and Value
It may start with a great idea; however, it is also essential to consider valuation when making buying decisions. A good quality small-cap will have demonstrated its viability with substantial sales growth but is still undervalued based on its market potential versus total market cap.
According to Laundon, the balance sheet is also important. He prefers companies with sufficient cash reserves to see them through any unforeseeable disruptions and little to no debt.
Motley Fool’s Advice on Small-Cap Stocks
Another prominent fan of small-cap stocks is online financial planning and investment advisory Motley Fool.
According to a recent blog posted on their website, the potential for significant returns made by investing wisely in small-cap stocks comes down to identifying businesses with the greatest capacity for long-term growth. To this effect, Motley Fool identifies two critical metrics: revenue growth and profit potential.
Revenue growth is probably the single most important factor to look for when picking a small-cap stock. These young companies should be able to deliver higher revenue growth than more mature enterprises. An attractive small-cap should be recording sustained revenue growth of at least 20%; if growth is declining, it could signal that the industry is maturing rapidly or was based on a temporary fad that has run its course.
This one is difficult for many new small-cap stock investors to digest: many small-cap companies are not profitable. However, this should not take away from long-term growth potential. Typically, these young small-cap companies are investing heavily to setting the stage for future growth, so even if they are not in the black right now, investors should focus on their ability to turn a profit later on.
It can be worth examining a company’s margins to gauge whether they are moving in the right direction towards profitability. However, instead of profit, investors should look at what value or competitive advantage a small-cap company has within their market.
Is BevCanna An Ideal Candidate for Small-Cap Stock?
BevCanna Enterprises Inc. (CSE: BEV) is a Canadian small-cap company with a diversified portfolio of alkaline, plant-based and cannabinoid beverages and supplements. In addition to their market-leading TRACE brand of mineral water, the Company also develops and manufactures cannabis-infused beverages and CBD-based natural health products for in-house and white label clients.
But are they a good small-cap opportunity?
Market Opportunity Test
The first question to answer is the cannabis-infused product market big enough and qualifiable enough to warrant investment in this stock. And the answer to that is a resounding yes.
The global cannabis drink market is ramping up. Currently, 15% of cannabis products purchased in the US are cannabis beverages, and one-in-four consumers say they want to try them. As recreational cannabis becomes legal in more states, this market share could witness explosive growth.
Recreational cannabis use is legal in 18 US states. But, over a dozen other states have taken steps to legalize medical cannabis use, which could signify that full legalization isn’t too far behind.
However, even if fully legalized cannabis in the US fails to materialize, the global cannabis drink market is projected to reach US$5.8 billion by 2024, up from US$1.82 billion at the end of 2020. Big-name alcholic beverage brands like AB InBev and Molson Coors have been pouring money onto the cannabis beverage market. And while challenges presented by the Covid pandemic have slowed production and marketing, this largely untapped market could be gearing up for a major surge.
Growth and Value Test
BevCanna has growth potential based on its entry into multiple segments of the drink market.
In February, BevCanna acquired Naturo. The deal landed the Company ownership of a proprietary on-site natural alkaline spring water aquifer, valued at $18 million, an established sales and distribution network of over 3,000 retail stores, the TRACE mineral beverage brand, and 315-acres of outdoor cultivable land and a 40,000 square foot high-capacity beverage facility valued at $10.4 million.
In July, wholly-owned subsidiary Naturo was selected by the British Columbia Ministry of Forests, Lands, Natural Resource Operations and Rural Development to manufacture and deliver a Special Limited-Edition TRACE-branded white-label water for the Ministry’s Wildfire Services Division.
BevCanna’s budding cannabis drinks segment was chosen by the #1 selling US cannabis beverage company Keef to be the exclusive manufacture and distributor for the brand in Canada. The Company recently completed its first commercial production run for Keef, and the products are now available in select Canadian retailers.
BevCanna also has value thanks to revenue potential from its distribution channels in Ontario, Alberta, and its white label business.
The Company recently received multi-product listings and subsequent purchase orders from the Ontario Cannabis Store (OCS) and the Alberta Gaming and Liquor Commission (AGLC) for both Keef brand products and white-label client Green Monké.
On August 19, BevCanna announced that it was adding another white label client to its cannabis drinks segment. The Company signed a manufacturing and distribution agreement with The Tinley Beverage Company Inc. (CSE: TNY) (TCQX: TNYBF) to co-manufacturer several of its award-winning cannabis-infused beverages for the Canadian market.
So, investors lookout. BevCanna is a promising small-cap stock worth watching if you are interested in the buzzing cannabis drink market.
Disclaimer: The company described in this article is a customer of NAI Interactive Ltd. This material is for informational purposes only and is not intended as a recommendation or offer or solicitation for the purchase or sale of any securities or financial instruments, or for transactions involving any financial instrument or trading strategy.