Small-cap stocks (stocks ranging between $50 million and $500 million) are a great place to look for outsized returns. Given their small size, they can multiply many times over without limitation. It only takes a few successful small-cap investments to make an investor wealthy.
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Small-cap stocks are volatile but highly rewarding
Of course, small-cap stocks can be riskier. Given their smaller size, they are not as well known by the market. Finding information can be challenging. Likewise, they are often more illiquid due to a smaller shareholder base. This can also lead to higher stock volatility.
Fortunately, you can avoid a lot of the pitfalls of small-cap investing by ensuring your stocks meet the following criteria:
- Is a profitable business
- Has a strong balance sheet (no or low debt)
- Is led by smart management
- Offers great product(s)/service(s) that can provide long-term growth
- Trades for a fair/reasonable valuation
You can avoid a lot of risk just by ensuring any small-cap stock you buy fit these criteria.
Now that we’ve talked about the risks of small-caps, let’s turn to the reward. Here a few stocks that took a $10,000 investment and grew it into more than $100,000.
An industrial that quickly multiplied
TerraVest Industries (TSX:TVK) is a fascinating example of a small cap stock that more than 10X’d. You could have bought this stock for less than $10 per share at the start of 2018. Today, it trades for $99.50. A $10,000 investment would be worth $101,765!
TerraVest has delivered a 42% annual average return in that period! It would not have been easy to pick out, however.
TerraVest does not exactly have an exciting business. It owns a mix of industrial businesses that include tank and trailer manufacturing, energy services, and boiler/heater sales. However, in 2018, the stock was dirt cheap, and the market didn’t recognize the power of its business model.
Its core strength has been its ability to buy cheap mom-and-pop industrial businesses, maximize cash flow generation, and then re-invest the cash into more businesses. It has used this to effectively compound investors’ capital.
While this stock would have required some sleuth small-cap investing, it just shows a little work can pay back enormously.
A small-cap stock with electrifying returns
Another small stock that traded under the radar for years is Hammond Power Solutions (TSX:HPS.A). This-family run business manufactures and sells high quality, specialized power transformers. Like TerraVest, there’s nothing flashy about it.
However, its founder-led management team prudently managed the business and steadily made it into a top power product business around the world. Today, the massive surge in power demand due to data centre/AI demand, electric vehicles, and a rising population should favour this business for many years to come.
You could have bought Hammond in early 2022 for less than $14 per share. Today, it is worth $149 per share. Its stock has grown by a 139% compound annual growth rate (CAGR) in the past three years. Over the past 10 years, it has compounded by a 35% CAGR.
The Foolish takeaway
Both TerraVest and Hammond Power matched the small-cap investing criteria I laid out above. The companies were small and under-followed by the market. As a result, the stocks remained cheap while the companies consistently grew profits and cash flows.
Eventually, they gained market recognition and the stocks really started to move. Look for similar types of businesses in the early stages, and you’ll have a chance to turn $10,000 into $100,000.
