As the calendar changes to a new year, it's once again time for investors to scour the stock market for intriguing bargains. For a lot of investors, large-cap stocks (those with a market cap of at least $10 billion) will be preferred due to the time-tested nature of their business models. But for investors seeking game-changing returns, the small-cap arena is where you'll want to look.
Small-cap stocks (those with market caps under $2 billion) tend to be considerably more volatile than large-cap companies, and their business models may, as of yet, be untested. In other words, they can be a far riskier investment than buying into a large, branded business. But because so many small-cap stocks have yet to be discovered by the masses, the potential for big gains is very much there.
In 2020, I've pinpointed the following three small-cap stocks as being particularly attractive.
Image source: Getty Images.
Innovative Industrial Properties
Despite marijuana stocks being an absolute train wreck in 2019, cannabis-focused real estate investment trust Innovative Industrial Properties (IIPR -0.17%) was a completely different breed of pot stock. That's because its business model of acquiring marijuana growing and processing facilities looks to be completely unaffected by a persistent black market and high tax rates in select U.S. states.
Innovative Industrial Properties began 2019 owning only 11 properties. It ended the year with a portfolio of 46 assets spread across 14 states. It's been especially easy for IIP to broaden its portfolio given that the U.S. is the most lucrative cannabis market in the world and access to financing remains scarce for U.S. multistate operators (MSO).
With marijuana remaining an illicit substance at the federal level, most MSOs have limited or no access to non-dilutive forms of financing. This paves the way for IIP, through sale-leaseback agreements, to purchase properties and then lease them back to the original owner for a long period of time (10 to 20 years). With the U.S. federal government highly unlikely to budge on marijuana's Schedule I classification in 2020, IIP's competitive advantage will remain in full force.
Also, unlike nearly all pot stocks, Innovative Industrial Properties is rolling in the green. IIP has been profitable for some time now and has a lower forward price-to-earnings ratio than the broad-based S&P 500. Additionally, with an average yield on its $489.3 million in invested capital of 13.6%, IIP should have a complete payback in just over five years.
IIP looks to be an extremely smart way to play the cannabis craze in 2020, and you'll receive a 5.4% yield to boot.
Image source: Lovesac.
Lovesac
Next, I'd encourage investors to take off their shoes and give home furnishing provider Lovesac (LOVE -0.05%) a closer look.
Unlike IIP and the next company on this list, Lovesac isn't profitable, but that's not scaring me away. Rather, I see multiple positives here that should drive Lovesac to profitability by 2021 or 2022.
For one, most of Lovesac's share price weakness last year was the result of the ongoing trade war between the U.S. and China. Tariffs wound up adding 25% to the cost of some core furniture products, leading the company to make supply chain changes and raise its prices. Since 2019 began, Lovesac has continued to transition its sourcing away from China and toward Vietnam, which should lead to a more stable cost environment in 2020.
Beyond just shifting production to Vietnam, I think it's worth noting how price hikes didn't adversely impact the company's business model last year. Net sales for 2019 are expected to have grown between 40% and 42%, with strong attachment rates for new products (i.e., consumers buying sets or matching accessories) and average order value continuing to climb. It's evident that Lovesac's products are resonating with consumers, and its growing retail presence, especially online, should help further drive top line growth.
Despite losing money, Lovesac still anticipates positive adjusted EBITDA for full-year 2019 and is valued at less than 1 times Wall Street's projected sales for 2020 (which assumes 40% sales growth). Just because it's not profitable yet doesn't mean it's not a value stock. Among the three small-cap stocks on this list, it's the one I've recently added to my own portfolio.
Image source: Getty Images.
CalAmp
Finally, I'd encourage investors to shrug off CalAmp's (CAMP 5.61%) less-than-appealing third-quarter results and focus on the progress that's been made for this maturing Internet of Things (IoT) company.
Similar to Lovesac, CalAmp's telematics business segment was plagued throughout 2019 by its ties to China. Importing from China had long been a cost-saving move, but tariffs wound up tacking on added expenses in 2019 that were difficult to absorb. The good news, though, is that CalAmp has reduced its reliance on China for telematics product imports from between 70% and 80% down to around 50%. This ongoing shift should lead to a lot more cost certainty in the current year.
But what's really exciting for CalAmp is just how quickly its software-as-a-service (SaaS) business is growing. Subscription-based business revenue skyrocketed 67% from the prior-year period in the third quarter, and accounted for 35% of total sales. Subscription revenue is highly predictable and resistant to recessionary declines, meaning CalAmp has been boosting its net sales floor with each passing quarter.
This is also a company that's very profitable, despite not having lived up to some very lofty expectations for IoT growth. CalAmp is valued at just 13 times forward-year earnings, less than 1 times 2020's consensus sales, and offers a price-earnings-to-growth ratio (PEG ratio) of 1.4, signifying room to run. As the company's businesses mature, we're liable to see mid-to-high single-digit growth from telematics, all while SaaS pushes toward 40% of total quarterly revenue.
CalAmp's recent "disappointments" have made it quite the bargain, and investors would be wise to scoop this top small-cap stock up in 2020.
