Small-cap stocks can be an attractive investment opportunity, as they stand a much larger chance of experiencing astronomical growth than a more stable, less volatile mid or large cap. However, with that volatility comes increased risk. Small caps bust out at a much higher frequency than their larger counterparts. This is especially true in Technology, where one major invention or development can sink a company faster than you can say “internet.”
Which tech sector small cap becomes the next Apple (AAPL) and which becomes the next AskJeeves can seem thoroughly arbitrary and random. But believing there might be a method to the madness, Equities.com has created the series Small-Cap Stars, to dig into the fundamentals that successful small caps seem to possess.
Small-Cap Stars was created by the analyst team at Equities.com, who identified specific criteria in every sector that seemed statistically significant in identifying winners. For the Technology sector, the analysts identified several benchmarks they found to be useful in predicting tech small-caps with a high chance of success, and created a watchlist based on stocks that met either one benchmark or all five. The benchmarks are:
Enterprise Value/EBIT:This ratio is used to determine whether a stock is undervalued relative to its peers.
Enterprise Value/Invested Capital:High return on invested capital means that management is spending money wisely to grow the business.
Reinvestment Rate:This metric measures how much of the company earnings are invested back into the business.
Pre-Tax Operating Margins:Pre-tax operating income is one of the best barometers for the basic health of a business, because it measures both the revenue and expenses associated with the company's primary business activities. High margins are vital to future success.
Cash as a Percent of Revenues:By far the most important factor in the model. Since the Tech industry can be finicky, cash can provide either survival or an opportunity to invest.
Here is a brief snippet of the best performing tech stocks on the watchlist this YTD:
Envestnet, Inc. (ENV)
Envestenet provides a platform for financial advisors, specifically wealth management technology. The company announced a second public offering on Oct 9. Last quarter the company reported profits of 13 cents a share, up 86 percent from the year prior.
Envestnet has returned 129.26 percent on the year, and currently sits at $29.25 a share.
Move Inc. (MOVE)
As their (sort of) implies, Move is involved in real estate, less broadly online real estate listings. Move owns realtor.com, a popular residential real estate search website. The company generates revenue by selling featured listings to brokers and other real estate professionals.
Move has returned 121.77 percent on the year, and currently sits at $16.71 a share.
Kongzhong Corporation (KONG)
This Chinese tech company provides a variety of video games, ringtones, internet games, and virtual goods. One of its most popular titles is World of Tanks, a Chinese multiplayer video game.
Kongzhong has returned 117.44 percent on the year, and currently sits at $10.71 a share.
Silicom Ltd. (SILC)
This tech company provides networking and data infrastructure solutions. The company soared earlier in the year after releasing an exuberant earnings report in January that described Q$ 2012 as their best quarter ever and 2012 as their best year – or, in their exact words, “HIT IT OUT OF THE BALLPARK.”
Silicom has continued marching upwards since, and has returned 106.49 percent on the year. The company’s shares currently sit at $35.78 a share.