Small-cap stocks tend to be more prone to volatile pricing swings than their large-cap peers, but it's also true that small-cap companies have outperformed large caps in recent decades. Investing in smaller, lesser-known companies tends to mean embracing a greater degree of uncertainty, but it's possible to see great returns with these stocks if you're willing to weather some short-term volatility and embrace a bit of speculation.
With that in mind, investors who are looking for big growth potential at appealing prices should consider building positions in Changyou.com (CYOU) and Himax Technologies (HIMX 1.03%) this month.
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Changyou.com
Changyou.com is a Chinese entertainment company that generates most of its revenue from video games that it develops and operates. The linchpin of the company's gaming business has been its Tian Long Bu Bu (TLBB) franchise -- a multiplayer online role-playing game series that lets players fight and train to master different kung fu disciplines in ancient settings loosely based on Buddhist texts and Chinese history.
The developer has a market capitalization of roughly $900 million, and while its earnings have slipped as titles in the TLBB franchise have lost some steam over the past few years due to increased competition, the company is still solidly profitable. Changyou recorded $486 million in revenue and net income of $78 million in 2018 -- down from the $127 million in profit it posted on sales of $580 million in 2017, but far from being a terrible performance when viewed in context.
Changyou trades at just 8.5 times this year's expected earnings, and it looks like the cheaply valued stock is primed for a rebound. While earnings performance for larger video game companies like Activision Blizzard and Electronic Arts has generally become steadier and more predictable as the rise of the games-as-a-service model has allowed them to keep multiple big properties active at the same time, business for smaller gaming companies is still a lot more cyclical. Here's the good news: Changyou is about to release new properties and build on top of its core franchise, and swing back into a growth phase.
The Chinese government has been supportive of the content of the TLBB franchise, and, barring any big changes, Changyou has permission to run its existing TLBB games in perpetuity without the need for additional licensing. The series gives the company a core business to work from, and sequential growth for revenue from TLBB Mobile last quarter suggests the property could be stabilizing. That's a tantalizing prospect, as recent comments from management suggest that the company's release pipeline will accelerate over the next few years, and that the business is in good position to launch new blockbuster titles.
The company has two new games due to debut this year, and management seems very confident about having the necessary licenses in order to launch its titles. It also has more than 10 titles in development, so it's not unreasonable to think that there could be fresh properties that are sales catalysts beyond 2019.
Changyou has great fundamental business strength: It has $673 million in cash and no debt, it is profitable, and its stock trades at attractively inexpensive multiples that price in very little potential for improvement in the business. It's not clear how the company's upcoming games will fare on the market, but investors have an opportunity to take an advantage of this dynamic and the outsize impact it's having on Changyou's valuation. The developer is creating new content and adjusting in-game settings in order to keep games in the TLBB franchise kicking. Success for just a couple of the projects in its pipeline would likely send the stock skyrocketing.
Himax Technologies
Himax Technologies is a Taiwanese company that designs chips called display drivers that are used for regulating the colors of pixels on mobile, television, and automobile screens. It also creates semiconductors used for a range of machine-vision solutions -- including 3D-facial scanning chips that have been in Apple handsets, but those businesses have been slower to pick up than investors have expected. The small-cap stock has suffered for it. Big time.
Even after falling roughly 70% over the past three years, it wouldn't be right to say that Himax Technologies stock is a low-risk investment. Shares are priced at roughly 45 times this year's expected earnings, and without much visibility on how the company's push to get the 3D imaging chips used in Apple devices into Android phones plays out, there's a lot of guesswork about what's ahead for the company. That said, the chip designer looks pretty beaten down at this point, and the stock is at levels that present substantial upside if the company manages to secure significant new design wins.
Himax has growth avenues in some exciting product categories that haven't really taken off yet, and the cost to develop the chips that are supposed to power its next growth stages is hurting performance. That helps explain why the stock still trades at such a high earnings multiple, and just 0.75 times 2019's expected sales, despite having sunk to the neighborhood of five-year price lows.
The relatively high prices of the company's 3D-scanning chips have dampened adoption in Android phones (which tend to be less expensive than Apple phones), and slower-than-expected adoption for consumer virtual reality and augmented reality headsets has put the short-term stymie on another potential growth avenue. It's no surprise that Himax stock has suffered in recent years, but the display and machine-vision markets still have plenty of growth potential, and there are a few rays of sunlight on the horizon that could signal a rebound for the business.
Display-driver chips account for roughly 80% Himax's sales, and the company actually anticipates that its smartphone display-driver business will ramp up this year, thanks to major manufacturers adopting its new solutions. That's expected to happen despite expectations that the worldwide market for mobile handsets will continue to be sluggish. Television and automotive sales should also be a tailwind for the display-driver business in the short term.
There are signs that the core display-driver business is stabilizing, and crucially, it looks like one of Himax's big growth bets in recent years might still pay off. The company says that it has Android-user chip customers for its 3D imaging chips that want to start manufacturing devices this year, and it looks like 2020 is setting up to be a big year for the company.
Next year, Himax expects to launch its next-generation low-cost, high-performance 3D-scanning chips in Android phone lines. If major Android phone manufacturers start using the company's chips in their core handset lines, Himax will likely see a substantial performance catalyst over the next few years. There's no guarantee that the chip company will finally deliver the long-promised success in the 3D-imaging and machine-vision markets, but for risk-tolerant investors looking for big upside, Himax is a small-cap stock that's worth buying this April.
