Want to hear a secret to success in investing that not everyone knows? Buy small-cap stocks. Between 1926 and 2006, small-cap stocks delivered a compound annual growth rate (CAGR) of 12.7% while the S&P 500 index generated an average return of 10.4%. And small-cap stocks have been neck and neck with the S&P 500 in total performance since 2006.
With this in mind, we asked three Motley Fool contributors to identify the top small-cap stocks they like right now. Here's why they picked Changyou.com (NASDAQ:CYOU), Gladstone Land Corporation (NASDAQ:LAND), and Viking Therapeutics (NASDAQ:VKTX).
Score big with this supercheap Chinese gaming company
Keith Noonan (Changyou.com): Most American investors won't know Changyou's video games, but its seriously discounted stock presents great value at current prices. The Chinese gaming company was spun off from Sohu in 2009 and managed to score a series of hits with its role-playing-game series TLBB. But business has slowed, and the lack of investor familiarity with is offerings meant that the stock never really got much attention on the Nasdaq. A series of gigantic special dividends paid to shareholders have had the effect of further reducing the company's size, and it now has a market capitalization of roughly $400 million.
Sohu remains Changyou's majority shareholder. The big special dividends were likely implemented in order to funnel cash back to the parent company and pave the way to take the gaming offshoot private. Changyou now trades at just 3.5 times this year's expected earnings, sports a price-to-book value of less than one, and still has roughly $170 million in cash. Backing out the cash position (and without taking real estate and other assets into account), the business trades at roughly two times this year's expected earnings. There's a good chance that the company will wind up getting bought out of a significant premium within the next couple of years, but the stock looks deeply undervalued even if that doesn't happen.
Changyou's TLBB franchise is still putting up solid results, helping the company to record non-GAAP (adjusted) net income of $78 million on revenue of $486 million last year. It's releasing new games this year and has somewhere around 10 games in its development pipeline. With the stock trading at deep-value prices and offering investors multiple ways to win, the often-overlooked gaming company stands out as a top small-cap stock to buy this month.
Betting the farm
Reuben Gregg Brewer (Gladstone Land): With a market cap of $240 million or so, Gladstone Land falls into the small-cap category, but this real estate investment trust's hefty 4.6% yield can add a notable boost to your income stream. The big deal here, however, is the type of property Gladstone Land owns: fruit, produce, nut, and berry farms. These tend to be more stable assets than grain farms (like corn and wheat), where commodity prices can vary widely from year to year and materially impact land values.
Gladstone Land has huge opportunities, too, as management estimates that over 85% of U.S. farmland is family-owned. That allows it ample room to step in and acquire smaller farms that wouldn't interest large buyers. It currently owns roughly 90 farms in 10 states with 100% occupancy. It made six property additions in the first seven months of 2019 alone. Meanwhile, the REIT has increased its dividend 15 times over the past 4.5 years. But, despite these facts, it is trading roughly 22% below its IPO price.
Gladstone Land is still in the growth phase of its life. Like all REITs, it raises capital for acquisitions by selling debt and equity. That can lead to a notable mismatch between raising cash and earning rent. In fact, the adjusted funds from operations payout ratio is roughly 100% and has frequently been higher than that. This is a worrying sign, but so far, the REIT has capably balanced its growth and dividend. Its crop focus, meanwhile, allows it to sign relatively long leases, providing a strong backstop to its revenues. Although not for the risk-averse, this tiny farm REIT could have years of growth (and dividend hikes) ahead of it.
High risk, high reward
Keith Speights (Viking Therapeutics): Clinical-stage biotech stocks aren't for the faint of heart. They can be super volatile. They can also cause you to lose a lot of money if their experimental drugs don't pan out. But for really aggressive investors willing to take on high risk in the hopes of gaining huge profits, Viking Therapeutics looks like a potentially good bet.
Viking's market cap stands at only a little over $500 million right now. That's actually quite pricey for a company that doesn't have any consistent revenue coming in the door. However, Viking claims several drugs with significant potential. The one that has generated the most excitement is VK2809.
Last year, Viking reported very encouraging results from a phase 2 clinical study evaluating VK2809 in treating nonalcoholic fatty liver disease (NAFLD). The biotech is moving ahead with another phase 2 study of the drug in targeting a specific type of NAFLD called nonalcoholic steatohepatitis (NASH). There's a huge unmet medical need for NASH, with no approved treatments for the disease as of yet.
Quite a few companies are scrambling to develop NASH drugs. Several of them are also looking at combination therapies. If Viking's phase 2 NASH study generates results that are as positive as its earlier NAFLD results were, I suspect the biotech will become an acquisition target for a larger drugmaker.
Again, Viking is a high-risk stock. But it's one that could easily deliver high rewards, too.