Passive investing, or owning index funds and exchange-traded funds (ETFs) comprising a representation of the broader stock market, isn't inherently good or bad. It's certainly easier than conducting research and due diligence into individual companies. But some investors are beginning to think that passive investing is creating a bubble.
Index funds attempting to mimic the whole S&P 500 or the Russell 2000 tend to leave out small-cap stocks. Put another way, the increasing popularity of passive investing is leaving a lot of small-cap stocks behind, even when operations suggest they deserve better. When Wall Street scrambles to correct its mistakes, shares of small-cap stocks can erupt for epic gains, as happened with Enphase Energy in 2019.
Two small-cap stocks that don't appear to be receiving their dues are Personalis (PSNL) and Intrepid Potash (IPI -0.69%). Each could fail to capture important market opportunities, but individual investors looking for under-the-radar stocks may want to get familiar with the businesses.
An overlooked genomics platform
Why only base decisions in clinical trials on 50 genes when you could look at all 20,000 or so genes in the human genome? That's the question Personalis poses to biopharmaceutical customers -- it just hasn't resonated yet. While revenue is growing compared to 2018 totals, just two customers generated 76% of revenue in the first six months of this year. But the potential is there.
Unlike most liquid biopsy tests and genomics assays, which provide information on only a handful of genes, the company's NeXT Platform provides a comprehensive view of all 20,000 human genes, in addition to the activity of certain immune cells. If it delivers on its promise of making the complexity of biology even a little easier to digest for customers, then it could make it easier to match patients to clinical trials, predict who will respond to a therapy, and even discover new drug candidates.
Total revenue grew 130% in the first half of 2019 compared to the year-ago period. While it took a considerable increase in operating expenses to achieve that growth, the business managed to keep its operating loss in check, losing $8.8 million in the first six months of 2018 and $9.5 million in the same period of this year. After arming itself with $140 million in cash from its initial public offering (IPO) a few months ago, investors might not be too concerned if minimal losses continue, so long as they continue to feed growth.
That's one problem for Wall Street, which appears to have overlooked Personalis in favor of faster-growing peers. The company expects to generate about $15 million in revenue each quarter this year. Although that will represent full-year 2019 revenue of at least $60 million and year-over-year growth of at least 59%, a lack of sequential growth is a little frustrating.
What's being overlooked is the fact that the business has been leaning on an intentionally expensive growth strategy and quietly expanding the commercial capabilities of its NeXT Platform. Personalis still needs to deliver on the potential of new products and diversify its customer base, but a market cap of just $450 million might encourage investors with an appetite for risk and a long-term mindset to take a deeper look.
Water sales or a slippery slope?
Intrepid Potash, a producer of major crop nutrients including potassium, in the form of potash, has made tremendous progress in recent years to bolster the efficiency and simplicity of operations. It converted all potash production to use solar evaporation ponds, which, after a significant ramp-up phase, are now churning out the lowest-cost product in the company's history. In 2018, the business once again leaned on simplicity to diversify revenue and monetize one of its most valuable assets: water.
The company's potash fertilizer production facilities are based in the Permian Basin, which also happens to be the world's most prolific oil-producing region. It just so happens that both solar evaporation ponds and fracking require a not-insignificant volume of water. That's worked out well for Intrepid Potash, which expects full-year 2019 water sales to oil and gas customers of $20 million to $30 million. The oilfield solutions segment, comprising mostly water revenue, enjoyed a gross margin of 53% in the first half of the year.
The combination of increased water sales, the higher average selling prices of potash, and lower costs of goods sold for its specialty fertilizer product have Intrepid Potash performing at a high level heading into the end of 2019. The business grew first-half 2019 revenue 6.7% compared to the year-ago period, although gross profit and operating income soared 82% and 440%, respectively, in that span. It generated $31.7 million in cash from operations in the first six months of this year, significantly better than the same period of 2018 once inventory writedowns are excluded.
Despite the progress, shares of the fertilizer producer have zigged and zagged their way to a 10% loss in the last year. That appears to undervalue the business, as the stock trades at 0.94 times book value. But the business could earn an even higher valuation if it continues to execute.
For instance, the company generated just $11.1 million in water sales in the first half of 2019, but management told investors it expects to deliver closer to the high end of the $20 million to $30 million range for the full year as new water pipelines come online in the Permian Basin. Another factor: Retail potash selling prices have risen for several years now. That trend could continue as American farmers look to make up for a historic loss of planted acres this past year. Simply put, an increasingly profitable Intrepid Potash seems well positioned to earn a higher valuation from Wall Street sooner or later, but investors still can't overlook the risk of investing in commodity-linked businesses.