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3 Small-Cap Stocks to Buy After Second-Quarter 2020 Earnings

By Nicholas Rossolillo - Aug 13, 2020 at 8:00AM

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These three companies reported strong growth in earnings during the height of the COVID-19 lockdown.

COVID-19 has sent the world into a tailspin, and rapid changes have been necessary for many businesses trying to manage during this time. As some operations that rely on in-person interactions are rendered redundant, the digital world is more important than ever. But as the economy begins to emerge from the pandemic-induced recession, the groundwork has been laid for a number of new small businesses to grow.

Investing in small-cap stocks brings some extra risk. Share prices can be volatile in the extreme, and there's a higher chance that larger peers will steamroll these small companies. Investors should plan on holding a number of these emerging stocks (I recommend at least 15 or more) and keeping positions in them modest (I usually start by buying 0.5% to 1% or less of my total portfolio value).

After the release of second-quarter 2020 results, three small-caps that remain on my radar are Appian (APPN 1.67%), Ontrak (OTRK -1.81%), and Digital Media Solutions (DMS -7.43%)

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Image source: Getty Images.

1. Appian: Low-code software robotics on relative sale

Low-code software development platform Appian has taken a hit along with other tech stocks as of late. Up nearly 60% on the year at one point, stock in the company is experiencing a slowdown in its trajectory during the current crisis. However, Q2 results were better than forecast, and management is expecting growth to pick up the pace again this summer.  

Specifically, revenue increased 2% to $66.8 million in the second quarter from a year ago, driven by a 30% gain in cloud-based software subscriptions, a 12% gain in overall subscriptions (cloud plus on-premises software licenses), and an 11% decline in professional services. While 2% overall growth is nothing to get excited about, the outlook provided a few months ago was for at least a 7% decline in sales as many of Appian's customers were pausing to reassess their spending on new technology.  

But it's clear that negative effects from the crisis are starting to wane. The outlook for the third quarter called for at least 28% growth in cloud subscriptions and overall revenue growth of at least 7%. Adjusted losses are expected to continue for now in the $10 million to $11 million range for the current quarter. With over $256 million in cash and equivalents and zero debt on the balance sheet, though, Appian has the ability to manage in lean times and keep expanding its reach.  

As to where its journey will take it in the decade ahead, this software development platform has a lot of options. There's no shortage of organizations out there that need to build new applications, and Appian's acquisition of a software robotics firm early in 2020 has yielded it integration partnerships with larger software service peers DocuSign and Box. This is a promising software technologist, and with the stock trading at 11.9 times trailing revenue, I'm interested in making another purchase.  

2. Ontrak: The future of healthcare is digital

Virtual healthcare isn't new, but it was thrust into the limelight during the lockdown. And why not? Faced with shelter-in-place orders, many households opted to make use of a phone or video conference consultation with a healthcare professional for the first time. And as many are finding out, making a trip to the doctor's office or clinic isn't a necessity anymore. 

Internet connectivity and mobile device capabilities have reached a point where telehealth can now go mainstream, and this expectation has sent shares of Livongo Health -- which is controversially merging with my biggest healthcare holding Teladoc Health -- soaring over 400% at one point this year.

But it's not the only game in town. Smaller peer Ontrak is now sporting a more than 200% gain so far in 2020, and for good reason.  

Ontrak specializes in virtual care for those with behavioral health conditions. Q2 membership (via an insurance plan, as Ontrak partners with health insurance providers) grew 203% from a year ago to 11,989. That equated to revenue of $17.6 million, a 124% increase, and management reiterated its full-year revenue guidance of $90 million (which would be a 156% increase over 2019). This is a tiny company with a current market cap of just $910 million, but it's building some serious momentum.

As mentioned, Ontrak isn't alone in the burgeoning virtual health market. It's slim on cash at the moment with just shy of $12.7 million on the books at the end of the last quarter (though it has access to lines of credit and can issue new stock to raise cash if it decides to do so). There are also critics of the company's serial entrepreneur founder and CEO Terren Peizer, as well as questions about the long-term efficacy of Ontrak's treatment of the notoriously difficult mental health field. But a laundry list of concerns is the norm with tiny upstart companies. Don't invest too much (I really can't stress this enough; my initial small-cap purchases are always less than 1% of my portfolio value), and let this promising health tech company naturally grow into a larger holding if it's destined for greatness.  

3. Digital Media Solutions: The new adtech on the block

Special purpose acquisition companies (SPACs) have emerged as a hot trend in recent months. Companies like DraftKings and Nikola have been taken public via a SPAC and have garnered plenty of investor attention. But one under-the-radar IPO is worth visiting: Digital Media Solutions.  

Upon going public in July, Digital Media Solutions shares fell over 30% but have since rallied close to their initial price on the back of solid Q2 results. Revenue grew 30% from a year ago to $75.2 million, and unlike the other two stocks on this list, DMS is profitable. Net income was slim at just $2.1 million, but this small advertising firm's bottom line is increasing at an even faster rate than sales as it scales its operations. Full-year revenue guidance of $340 million also implies it will notch strong sequential growth during the second half of the year (as first half 2020 revenue was only $148 million).  

With an already massive shift to digital advertising underway, 2020 has seen the pace of transition from traditional ad spend pick up in pace. Digital Media Solutions is in good position here. The company offers pay-for-performance ad campaigns, tying its own success to the success of its customers. Ultimately, it's not the highest-profit-margin approach to the digital marketing industry (gross margin on services rendered was 30% in Q2), but DMS' business shouldn't be ignored in the years ahead as organizations look for a trusted partner to help them update their customer acquisition methods.  

With a market cap of only $580 million, Digital Media Solutions is trading for just 1.7 times expected sales. If it can maintain its momentum in this new era of digital ads, I think this new stock will attract some serious attention and could have plenty of upside potential.

Nicholas Rossolillo and his clients own shares of Appian, Digital Media Solutions, Inc., Livongo Health Inc, Nikola, Ontrak, Inc., and Teladoc Health. The Motley Fool owns shares of and recommends Appian, Box, DocuSign, Livongo Health Inc, and Teladoc Health. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Appian Stock Quote
$55.37 (1.67%) $0.91
Ontrak, Inc. Stock Quote
Ontrak, Inc.
$0.68 (-1.81%) $0.01
Digital Media Solutions, Inc. Stock Quote
Digital Media Solutions, Inc.
$1.37 (-7.43%) $0.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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