2 Exciting Small Caps With Room to Run

Small caps tend to offer more risk but more potential reward.

Jul 16, 2014 at 6:45PM

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some small-cap growth companies to your portfolio, but don't have the time or expertise to hand-pick a few, the Vanguard Small Cap Growth ETF (NYSEMKT:VBK) could save you a lot of trouble. Instead of trying to figure out which stocks will perform best, you can use this exchange-traded fund to invest in lots of small-cap growth companies simultaneously.

Why this ETF, and why small-cap growth companies?
A well-diversified portfolio can reduce your risk, and small-cap companies offer exceptional room for growth. According to the Ibbotson SBBI 2013 Classic Yearbook, large-cap stocks have returned an average of 9.8% annually between 1926 and 2012, while small caps have averaged 11.9%. Still, there are signs that small caps have gotten ahead of themselves, with the forward P/E for the Russell 2000 recently sitting at 19.3, far higher than the S&P 500's 16.5. Still, even within overheated sectors, you can find attractive buys.

ETFs often sport lower expense ratios than their mutual fund cousins. The Vanguard Small Cap Growth ETF is no exception, with a tiny annual fee of 0.09% -- far smaller than just about any rival. It has outperformed the large-cap S&P 500 over the past five and 10 years, but not the past three.

A closer look at some components
On your own you might not have selected W. P. Carey Inc (NYSE:WPC) or Medivation Inc (NASDAQ:MDVN) as small-cap growth companies for your portfolio, but this ETF recently counted them among its holdings, which number roughly 700.

W. P. Carey
W. P. Carey converted to a real-estate investment trust a few years ago, meaning that it must pay out at least 90% of its income in the form of dividends. It recently yielded 5.5% and has been upping its payout by an annual average of 5% since it went public in 1998. The company focuses on commercial properties that are generally triple-net leased to single corporate tenants. (Triple-net leases place the responsibility of paying for property taxes, insurance, and maintenance on tenants, not landlords.)

W. P. Carey is attractive for a bunch of reasons, including a geographically diversified portfolio (a third of its assets are outside the U.S.), long-term leases averaging about nine years, and a high occupancy rate -- recently around 98%.

The stock's recent P/E of 33 is well above its five-year average of 26, so it doesn't appear to be a screaming bargain right now, but it's worth adding to a watchlist in case of a pullback. W. P. Carey is well run and executing a smart strategy effectively.

Medivation is a biopharmaceutical company that has rewarded long-term shareholders with an average annual gain of more than 50% over the past decade -- though growth has slowed down a bit recently. The company is focused mainly on tackling cancer, and its main drug is Xtandi, for advanced prostate cancer. In the company's last quarter, it reported that sales of Xtandi grew 65% year over year in the U.S. and exploded from $300,000 to $48 million outside the U.S. Better still, if the drug is approved for pre-chemo patients, its potential will grow significantly.

Like many small biotech companies, Medivation remains unprofitable, but it does have a successful product on the market, and its losses are narrowing. Revenue has more than quadrupled over the past five years, and to its credit, share count has not been rising too quickly. Still, reliance on one product is risky, and Xtandi does face some competition. Given the company's potential, though, it bears watching, or perhaps even buying, for those who aren't too risk-averse.

The big picture
It makes sense to consider adding some small-cap growth companies to your portfolio. You can do so easily via an ETF. Alternatively, you might simply investigate its holdings and then cherry-pick from among them after doing some research on your own.

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Longtime Fool specialist Selena Maranjian, whom you can follow on Twitter, has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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