Sometimes small companies, outside the reach of the big dollars of billionaires, can provide some of the best opportunities on the market.
We asked three of our investors for some great small-cap ideas and Fogo de Chao Inc. (NASDAQ: FOGO), Ignyta Inc. (NASDAQ: RXDX), and JinkoSolar Holdings Co. (NYSE:JKS) came to the top of the list. Here's why.
A tiny restaurant chain
Tim Green (Fogo de Chao): Small companies, with market capitalizations measured in the hundreds of millions of dollars, are often too small to move the needle for billionaire investors. Ordinary investors, on the other hand, have a wider variety of options. One good option is Fogo de Chao, a small chain of upscale Brazilian steakhouses. While growth potential is somewhat limited, strong profitability and a reasonable valuation make the stock an interesting small-cap choice.
Fogo de Chao operated 47 restaurants, 10 of which are in Brazil, at the end of the first quarter. The company expects to open seven restaurants during 2017, as well as a couple of joint venture locations. There's certainly room for expansion in the U.S., but this isn't a chain that will have hundreds of locations. Fogo de Chao charges around $50 per person, depending on the location, for its "Full Churrasco Experience," which features servers continually walking around the dining room offering a wide variety, and unlimited quantity, of Brazilian meats.
Fogo de Chao produced $24 million of net income on $288 million of sales last year, driven by a gross margin of around 30% and an operating margin of 13.3%. With the company valued at roughly $380 million, investors are paying just under 16 times earnings for the stock. Don't expect rapid growth, but slow and steady restaurant growth coupled with strong profitability make Fogo de Chao a stock to consider.
Small but precise
Cory Renauer (Ignyta Inc.): The biotech space is chock-full of small companies that big-time investors can't touch without making a major splash. Most aren't worth a second look no matter how much you have to invest, but this little gem has a stable of new cancer drug candidates well worth your attention.
As Ignyta's ticker symbol implies, the company's taking a combined approach that involves diagnostics and drugs to eradicate cancer. Although we still separate cancer into types based on the body part where tumors first appear, oncologists know that certain therapies are more effective when matched with disease driven by certain genetic aberrations regardless of where it first took hold.
Ignyta's path to glory involves using in-house screening techniques to select a small but well-defined group of patients for whom its new drug candidates are best suited to treat effectively. Its most advanced candidate, entrectinib, is in a clinical trial that could lead to new drug applications for the treatment of patients with tumors that test positive for specific mutations. At an interim analysis, the candidate shrank ROS1 mutation positive lung cancer tumors for 24 of 32 patients.
Such a high response rate should be enough to earn a green light from the Food and Drug Administration on its own, but entrectinib's surprising activity in the central nervous system (CNS) could make an eventual launch a success. Disease had spread to the CNS of 11 patients observed at the interim, an area that is notoriously difficult to treat. Despite the challenge, entrectinib shrank tumors among seven of them.
If final results from the entrectinib trial fall in line with interim observations, the company could deliver its first new drug application to the FDA next year. American oncologists diagnose an estimated 2,000 patients each year ROS1 positive lung cancer, which suggests an approval for this indication alone would justify the company's relatively small $537 million market cap at the moment.
A small solar play with big potential
Travis Hoium (JinkoSolar): When billionaires buy a company, they often want to have a large stake in it and/or control over its direction. In JinkoSolar, billionaires are getting neither.
JinkoSolar is one of the world's largest solar manufacturers, but its market cap is only $869 million, and as a Chinese company, its shares are really American depositary shares (so are intended to mirror actual shares in China), and it isn't structured like a U.S. company. Taking control of the company would be very hard for a billionaire, even if they wanted to.
None of this means that JinkoSolar can't be a long-term winner for investors taking a small stake in the company. JinkoSolar is a leader in the solar industry, shipping 2.1 GW of solar in the first quarter, enough to power 340,000 homes, and generating $839.3 million in revenue. Just $8.8 million flowed to the bottom line in the form of net income, but financial results are very volatile in solar.
What I like about JinkoSolar right now is its scale and the fact that management hasn't overleveraged the company. It has $886.0 million in interest-bearing debt and $249.0 million in cash with another $806.9 million in receivables and $780.2 million in inventory.
The best companies in solar are starting to emerge as customers look for the highest-quality partners to work with in building projects. Scale and a solid balance sheet comprise a formula that is highly likely to do well, giving JinkoSolar a strong chance of success in this multitrillion-dollar market.