Well-chosen small-cap stocks can create fortunes for investors. Businesses with market capitalizations below $2 billion are small enough to easily increase multiple times in value if they're successful.
Of course, that's a big if.
Many small companies fail to fulfill their potential. Some may fail completely, destroying shareholders' equity in the process.
To reduce those risks -- and to enhance your odds of investing success -- seek out competitively advantaged businesses that are well-positioned to succeed in large and growing industries. Businesses like the three that follow.
Profiting from the growth of freelancing
Upwork (NASDAQ:UPWK) helps to connect freelancers and the employers seeking their services. It's the world's largest marketplace in this regard, with more than 100,000 businesses spending at least $5,000 on its platform.
In all, Upwork's gross services volume -- the amount paid to freelancers through its network -- jumped 28% year over year to $1.76 billion in 2018. Yet despite this impressive growth, Upwork accounts for only a small fraction of the more than $500 billion earned by freelancers annually. Moreover, research firm McKinsey Global Institute expects this figure to grow to $2.7 trillion by 2025. Clearly, Upwork has a massive growth opportunity.
As the largest freelancer platform, Upwork benefits from powerful network effects. Each additional freelancer who joins its platform helps to make its talent pool more attractive to employers. And each additional business that joins its network adds to the pool of potential jobs for freelancers. That's a virtuous cycle that should help to fuel Upwork's growth.
As a freshly public company seeking to rapidly expand its share of an enormous market, Upwork is not yet GAAP profitable. But its margins should improve as it scales its operations. Platform businesses can have high margins; for example, eBay's operating margins typically check in at more than 20%. Upwork could approach that level of profitability in time.
Despite its intriguing growth potential, Upwork is currently trading for only about 13% above its October IPO price of $15. That places its market capitalization at approximately $1.8 billion -- a level that drastically undervalues its long-term opportunities. As such, investors may want to consider buying some shares today.
The real estate industry is ripe for disruption. Sellers have long had little choice but to pay a significant portion of the value of their homes to real estate agents.
Redfin (NASDAQ:RDFN) wants to help change that antiquated model. The discount brokerage's internet-based approach and salaried agents enable it to charge fees as low as 1% of the sale price of a house -- about one-third of the typical 3% seller's agent fee. Home buyers can save by using Redfin, too. The company offers buyers a commission refund of $1,700 on average.
By providing its customers with an opportunity to save a lot of money, Redfin is rapidly gaining market share in the $80 billion U.S. brokerage industry. It accounted for 0.81% of the value of existing home sales in 2018, up from 0.67% in 2017 and 0.33% back in 2014. Yet with its share of this huge market still at less than 1%, Redfin has long runways for growth ahead.
Redfin is also expanding into other high-potential markets such as mortgages and title services. In addition to helping to fuel its growth, these services strengthen its core brokerage business by facilitating the processes of buying and selling a home. Due in part to the convenience and cost savings it provides, Redfin enjoys customer satisfaction scores that are approximately 50% higher than rival brokerages.
Like Upwork, Redfin is currently trading for less than 20% more than its July 2017 IPO price of $15. And, similar to Upwork, Redfin's $1.6 billion market cap also significantly underrates its massive growth potential.
For these reasons, Redfin is another excellent small-cap stock to consider buying today.
The cannabis play
Investors interested in the profit opportunities possible in real estate may also want to consider Innovative Industrial Properties (NYSE:IIPR). The real estate investment trust (REIT) operates in a lucrative niche of this enormous market -- one that also gives investors a chance to claim their share of a cannabis industry that could generate $200 billion in annual sales within the coming decade.
Innovative Industrial Properties purchases regulated facilities used to produce medical marijuana and leases them to state-licensed growers. IIP owns 24 properties in 12 U.S. states totaling approximately 1.8 million rentable square feet.
With average lease lengths of nearly 15 years, these properties generate bountiful, recurring cash flows. And because it's a REIT, IIP passes nearly all of this cash on to investors in the form of a quickly growing dividend, which currently yields 2.2%.
IIP recently raised about $164 million in fresh capital in a secondary offering. The stock sold off on news of the sale, and is now down more than 20% from its 2019 high. Yet the company plans to use the cash to buy more cannabis-growing properties, which should help to fuel its growth.
Its current market cap of $1.2 billion places it squarely in small-cap territory. But by helping to facilitate the growth of the medical marijuana industry, IIP could easily become a much larger company over the next decade. As such, investors who buy today could be well rewarded the years ahead.