The law of big numbers makes it hard for large-cap companies to generate breakneck sales growth and market-trouncing returns, and that can make investing in small-cap stocks advantageous. However, winning market share away from established competitors or revolutionizing how people do business can be costly, and there's no guarantee small-cap companies will become bigger companies. Investors have to carefully consider which small-cap stocks are worth buying, so we asked three Motley Fool contributors what up-and-coming stocks are on their radar now. They responded with Baozun (BZUN 7.17%), Redfin (RDFN -1.68%), and HEXO Corp. (HEXO -2.04%). Read on to learn:
- Why it could be smart to ignore recent weakness in Baozun,
- How technology is letting Redfin shake up a massive market, and
- If marijuana legalization is going to cause HEXO's shares to soar.
Time to take China and Baozun out of the penalty box
Jamal Carnette, CFA (Baozun Inc.): We at The Motley Fool know the best way to outperform the market is to be greedy when others are fearful and buy high-quality companies on sale. Chinese e-commerce solution Baozun fits the bill on both accounts: Last year a combination of a broader tech sector sell-off coupled with fears of trade wars and slowing growth in China pulled the stock down 7%.
Meanwhile, the company continues to execute on its long-term vision. Last year the company reported 30% growth over the year prior. Although revenue has decelerated, some of which is natural and expected, this is also strategic, as it shifts to higher-margin services and consignment.
Perhaps a better line item to understand Baozun's strategy is operating income, which increased 39% over the prior year to 355.8 million yuan. Even more impressive is that this occurred despite a near doubling of technology and content spending (R&D), from 140.7 million yuan to 269 million yuan.
In the short run, look for more volatility from Chinese tech stocks, Baozun included, as talk of trade wars dominate headlines. However, long-term investors who can endure volatility should put this small-cap stock on their radars.
Simplifying home brokerage with technology
Nicholas Rossolillo (Redfin): Buying and selling a home is hard work. And then there's the cost, another pain point for anyone who has ever tried to relocate from one house to another. Technology-driven brokerage Redfin is trying to change the status quo, and with a valuation of only $1.8 billion as of this writing, it's still very early days for this big-potential stock.
Redfin uses its software to streamline the paperwork process of buying and selling real estate, and sellers pay as low as a 1% listing fee (which doesn't include the buyer's agent fee, usually 2.5% to 3%). Both sides of the deal get access to the country's largest home brokerage website. The kicker is that the lower listing cost doesn't mean worse service; in fact, Redfin has its own local agents, made even more efficient and helpful via the use of digital tools.
But why consider the stock now? Redfin is growing fast and has plenty of room to keep going. Revenue in 2018 increased 30% over 2017 to $487 million. The company's total share of the U.S. real estate market -- as measured by value of homes sold -- grew a tenth of a percent to 0.81%. That's a tiny fraction of the whole industry, but a big gain on a percentage basis.
The key to growth is continued expansion to new cities. Redfin serves only 85 in the U.S. and Canada at the moment, relying on a referral network of other brokers in markets it isn't in currently. Redfin is making the push into new areas, though, adding agents in new cities to capture market share with its technology-driven platform. It's worth noting that Redfin loses money -- but it's all about growth right now and profits later. That makes for one volatile stock, but with the company forecasting at least 27% revenue growth to kick off 2019, this real estate broker is worth a look for those willing to give it some time to develop.
Marijuana sales are about to skyrocket
Todd Campbell (HEXO): The marijuana market is worth $150 billion worldwide, and increasingly, spending is shifting from the shadows to legal, regulated markets, including in Canada, where a recreational, adult-use marketplace opened last October.
The potential in Canada is significant. About $6 billion per year is spent in Canada on marijuana every year, and as of the fourth quarter, only 20% of that spending was being done legally.
As more money moves from the black market to Canada's legal, adult-use market, Canada's leading marijuana stocks should experience tremendous sales growth. Although HEXO isn't the biggest cannabis company, it has roughly 30% market share in Quebec, Canada's second-largest province by population, and it plans to increase its penetration elsewhere. HEXO estimates it will supply over 200,000 kilos of marijuana to Quebec in the first five years following recreational sales, and its recent decision to acquire Newstrike allows it to sell marijuana in 8 of Canada's 10 provinces, up from three provinces last quarter.
The potential to capture more of the Canadian market has prompted management to guide for 400 million Canadian dollars in revenue in fiscal 2020, up from its current annualized pace of CA$64 million. With revenue growth like that, picking up HEXO in small-cap portfolios could be a profit-friendly, long-term decision.