This article was updated on March 15, 2017, and originally published Oct. 31, 2016.
The threat rising interest rates pose to financing has kept a lid on small-cap returns. However, some small-cap technology stocks have rallied significantly.
While no one knows if these fast-growing small companies will continue to reward investors, these three stocks are winning new business in big markets ripe for disruption, and that may make them the perfect stocks to add to growth portfolios now.
No. 1: Managing the Internet of Things
Internet-connected devices are creating long-tail revenue opportunities for companies that help consumers manage them, and one of the most intriguing of these Internet of Things plays is Alarm.com Holdings Inc. (NASDAQ:ALRM), a small-cap company that's reimagining how homeowners monitor and interact with their homes.
Alarm.com merges security with convenience through a simple, one-stop online portal that allows consumers to do things like monitor their home, manage their home's temperature, and control lighting. The single-portal approach is resonating with consumers. Alarm.com already boasts 2.6 million subscribers, and that figure should continue growing, given that the home security market alone includes over 22 million homes. Alarm.com's installers are adding about 10,000 to 15,000 properties per week to their service.
The majority of Alarm.com's sales come through profit-friendly recurring revenue streams (service and licenses), and with a renewal rate of 93%, there's plenty of clarity about future sales and profit. In Q3 2016, total revenue clocked in at $68 million, up 26% year over year, and adjusted EPS was $0.19, up from $0.14 a year previous.
The trend toward outfitting homes with 21st-century technology should offer intriguing growth opportunities for Alarm.com, and since Alarm.com already makes money, cross-selling additional services to an increasingly bigger customer base makes this company's future look pretty secure.
No. 2: Simplifying collaboration
LogMeIn, Inc. (NASDAQ:LOGM) appears better positioned than anyone else to provide businesses and employees with convenience and flexibility. LogMeIn is well-known for software-as-a-service solutions that allow people to access devices and collaborate together from anywhere, and in July 2016, the company announced that it's combining with Citrix's GoTo business to form a $1 billion revenue cloud software company.
After determining that GoTo's video communication solutions weren't core to its long-term strategy, Citrix decided to spin off GoTo in 2015. Acquiring GoTo adds roughly $630 million in sales to LogMeIn's already fast-growing top line. It also offers LogMeIn an opportunity to cross-sell its legacy products to GoTo's massive client base. Furthermore, LogMeIn targets a profit-friendly $100 million or more in savings per year over time.
LogMeIn's sales grew 16% year over year to $88 million in Q4 2016 and its $0.62 in EPS was nicely above the $0.51 reported in the same quarter a year ago. Management thinks the addition of GoTo's business will result in LogMeIn's full-year sales eclipsing $1 billion in 2017. It also estimates its non-GAAP EPS will exceed $3.64 this year.
Overall, the combination of GoTo and LogMeIn could make this company a powerhouse in cloud productivity software, and for that reason, I think there's room left for shares to run higher.
No. 3: Streamlining human resources
Small and mid-size companies often roll in HR solutions as they grow, and that approach can create fragmented HR databases that provide incomplete and contradictory insight. Paycom Software Inc.'s (NYSE:PAYC) single-database HR solution eliminates the headaches associated with integrating multiple vendors, allowing clients to better manage HR functions, such as recruitment and onboarding, payroll, and benefit management.
Although the HR-solutions market is competitive, Paycom is one of the only solution providers that was built from the ground up for the internet, and frankly, I think its Midwest HQ provides it with some cost advantages over competitors located in pricier markets, such as California. While large companies are likely to continue sticking with software solutions that bigger companies offer, including Oracle, I think there's still a significant greenfield opportunity for Paycom in the mid-size market. If I'm right, then Paycom should be able to continue delivering robust double-digit growth in 2017, and that could make its shares worth stashing away.