This year has tested the resolve of investors like few years before it. Through the first six months of 2022, the benchmark S&P 500 delivered its worst return since 1970, while the growth-centric Nasdaq Composite screamed into bear market territory.
Yet in spite of this turmoil, my belief that select small-cap stocks can significantly outperform over the long run remains unchanged. A “small-cap stock” is traditionally defined as a publicly traded company with a market cap between $300 million and $2 billion.
Although small-cap companies often come with added risks during periods of volatility (e.g., they may not be profitable and/or time-tested), they can provide exceptional growth potential and innovation. It only takes one or two big wins in the small-cap space to generate life-changing money over the long run.
As of the closing bell on Aug. 25, 2022, four of my top eight holdings by percentage weighting were small-cap stocks. With these four stocks collectively making up over 18% of my invested assets, there’s little question that I’m betting the farm on select small-cap outperformance.
The first relatively tiny stock I’ve made a big long-term bet on is cloud-based programmatic adtech company PubMatic (PUBM -3.50%). Among the 43 stocks I have positions in, PubMatic lines up as No. 8 among invested assets.
PubMatic is a programmatic ad sell-side provider (SSPs). In plain English, this means it helps publishers sell their digital display space to advertisers using automated software. Due to industry consolidation, there aren’t too many SSPs for publishers to choose from.
If there’s such a thing as a no-brainer reason to buy PubMatic, it’s that ad dollars are continually shifting away from print and traditional cable to digital formats, such as video, mobile, and over-the-top streaming channels. Whereas the digital ad industry is expected to enjoy average annual growth of around 10% through the midpoint of the decade, PubMatic’s annual organic growth rate has consistently ranged between 20% and 50% over the past couple of years. This is both a reflection of the few choices in the SSP space, as well as the company’s programmatic ad platform keeping advertisers and publishers happy with relevant ad placement.
What’s more, PubMatic designed and built its own cloud infrastructure to run its programmatic ad platform. Although this was a time-consuming and costly venture, it should translate into notably higher margins than other SSP’s reliant on third-party infrastructure.
With $183 million in cash, cash equivalents, and marketable securities, and no debt, PubMatic looks to be in great shape to sustain double-digit growth throughout the decade, if not well beyond.
As someone who’s been a pet owner for virtually their entire life, I can attest that wallets open wide when it comes to the health and well-being of your furry, gilled, feathered, or scaled family member. According to data from the American Pet Products Association, it’s been well over a quarter of a century since year-over-year pet expenditures in the U.S. declined. In short, not even the worst recession in decades has slowed spending on pets.
What’s makes Bark so attractive is the company’s operating model. Though Bark’s products can be found in tens of thousands of retail doors across the country, the real lure is its online subscription service. As of the end of June, Bark had almost 2.28 million active subscribers and was generating approximately 90% of its sales from its direct-to-consumer segment. This is important, because it’s a lot cheaper for a company to manage inventory if the bulk of its revenue derives from predictable subscriptions. Not surprisingly, Bark’s gross margin has primarily hovered around 60%.
Bark’s innovation is a key growth driver as well. During the pandemic, the company introduced Bark Home for common accessories (e.g., beds, leashes, and collars), Bark Bright for canine dental needs, and Bark Eats, which’ll target dry-food diets for specific dog breeds. These new additions are fueling add-on sales and should be key to pushing Bark toward recurring profitability within the next two years.
The third small-cap stock I’ve piled into over the past two-plus years is furniture company Lovesac (LOVE -5.59%), which makes up more than 3% of my invested assets and is my seventh-largest holding.
Simply saying the words “furniture stock” is often enough to put most investors to sleep. That’s because the furniture industry is based on a stodgy brick-and-mortar model that’s highly dependent on foot traffic and the same small group of wholesale furniture providers. Lovesac is throwing most of this traditional approach out the window — and it’s working.
One of the bigger differences between Lovesac and every other furniture provider is… its furniture. Though it was initially known for its beanbag-styled chairs called “sacs,” roughly 88% of the company’s net sales now come from sactionals — i.e., modular couches that can be rearranged dozens of ways to fit most living spaces. Sactionals have over 200 different cover choices, can be fitted with a number of upgrades, such as premium surround-sound and wireless charging stations, and the yarn used in their covers is made entirely from recycled plastic water bottles. Its ecofriendly, functional furniture all in one.
The other significant change from traditional furniture retailers is Lovesac’s reliance on its omnichannel sales platform. For instance, the company shifted close to half of its sales online during the height of the pandemic. It’s also forged a number of in-store partnerships and operates popup showrooms to familiarize the public with its products. This omnichannel approach has lowered its overhead expenses and pushed Lovesac into recurring profitability years ahead of Wall Street’s forecast.
First Majestic Silver
The fourth and final small-cap stock I’m betting the farm on is silver miner First Majestic Silver (AG -5.00%). I came to own First Majestic as the result of its acquisition of Primero Mining in May 2018. It currently accounts for almost 6% of my invested assets and sits behind Bark as my fourth-largest holding.
The way I see it, there are macro and company-specific reasons to be optimistic about the future of silver and one of the biggest producers of silver in the world, First Majestic.
On a macro level, all signs point to silver demand steadily increasing throughout the decade. Although recessions can dent silver demand over very short periods, the lustrous metal is a key component used in solar panels and multiple components for next-generation vehicles. Effectively, the green-energy push should create a sustained boom for the silver-mining industry.
To add to this point, the gold-to-silver ratio is at 91, which is well above its historic average of closer to 60. This would imply that silver is more likely to outperform gold in the years to come.
On a company-specific basis, First Majestic Silver is poised to benefit from sustained gold and silver-equivalent output at the low-cost San Dimas mine, as well as a number of projects aimed at lowering ongoing operating expenses at the company’s four operating mines in Mexico. Between the ramp-up of the recently acquired Jerritt Canyon gold mine and new production expected from San Dimas, First Majestic looks to be on track to generate almost twice the silver-equivalent output this year as it did in 2017.