Many investors have a simple reason for choosing to leave small-cap stocks out of their portfolios. While these companies as a group tend to perform better than the wider market, the risk of owning them is amplified by their relatively unproven market positions. And, even if you find a winning business, you're likely to have to endure intense volatility on your way to booking those market-beating returns.
However, knowing the key risks before buying a small-cap stock can help you weather those inevitable periods of intense share price swings. Restricting purchases to high-quality companies with attractive growth potential, meanwhile, puts you in the best possible position to earn solid returns from investing in small-cap stocks.
With that balance in mind, let's look at a few small companies that appear to have what it takes to generate healthy long-term gains.
1. Stitch Fix
Stitch Fix ( SFIX 0.96% ) shares have been intensely volatile in 2019, with gains ranging from 90% to the current 16% increase on the year. Yet the e-commerce specialist, which is hoping to disrupt the apparel industry, has stayed right on its impressive growth path through those wide swings.
Sales jumped 29% in the fiscal third quarter as the company crossed 3.1 million active clients. That growth appears well grounded, too, with revenue per active client rising 8%. Other engagement and loyalty metrics are also heading in the right direction, including repeat orders and customer satisfaction.
Investors are worried about competition coming from far larger companies including Amazon, and those concerns might color the response to Stitch Fix's upcoming earnings report set for Oct. 1. However, sentiment could quickly recover as CEO Katrina Lake and her team build out their client base in the core female demographic while pushing into new areas like men's and kids' wear over the next few quarters.
Robotic cleaning device specialist iRobot ( IRBT -1.82% ) wouldn't have qualified as a small-cap stock just a few months ago when its market capitalization was bumping up against the $4 billion mark. But several negative factors have combined to send shares lower by almost 50% since then.
The company is caught in the crossfire of a tough trade war between the U.S. and China, for one. Not only is the spat raising costs for manufacturing those Roomba vacuum cleaners, but it's also slowing industry growth overall. The expansion challenges are no doubt amplified by continued competitive intrusions into this small but quickly growing industry niche.
CEO Colin Angle has predicted that sales gains will eventually rebound as costs return to their normal levels. iRobot is working to remove its tariff risk, too, by spreading out its manufacturing base beyond China. The bad news is that it will take time before that initiative insulates it from trade skirmishes.
On the bright side, demand for its latest products is strong. iRobot's dominant market position is likely to hold up as well, since its competitors are all in the same boat when it comes to dealing with spiking costs. Those factors lay the groundwork for a potentially sharp rebound in the stock after trade issues fade away. But shareholders will have to be willing to see their investments swing in value as they wait for more clarity about the short-term direction of iRobot's otherwise healthy business.