The COVID-19 pandemic has challenged many smaller companies. Investors who favor stocks below $2 billion in market capitalization for growth potential are probably wondering if it's safe to put new money there with so many uncertainties about how the pandemic is going to play out in the coming months. It's a very good question, especially since many growth stocks have already bounced back, and the share prices of some of the best growth stocks don't seem to be discounting the risks.
Fortunately, there still are some good buys in small-cap stocks, especially in industries where the market still seems to be wary of pandemic risks. The advertising business is still shaky, but Magnite (MGNI 2.72%) is a small-cap stock with big-cap potential. Retail stocks have rebounded, but those of their landlords haven't, and Retail Opportunity Investments Corporation (ROIC 0.98%) stands out as a relatively safe place to put $1,000 of your hard-earned savings. Lastly, medical equipment stocks were hit when routine procedures were put on hold, but that has barely fazed little Zynex (ZYXI -2.11%), which continues put up remarkable growth numbers.
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Magnite
The pandemic caused a rapid decline in advertising spending that caused most stocks in that industry to tumble. While that spending has been recovering, shares of Magnite, the world's largest independent sell-side advertising platform, are still 46% below their high of earlier this year. Investors have a short-term opportunity as the recovery continues to play out, but the stock should benefit from some strong long-term trends as well.
Buy-side digital ad platforms give content publishers a way to auction off ad space to advertisers. Magnite, formerly The Rubicon Project, merged earlier this year with Telaria, a platform for selling ads on connected TV (CTV). The combined company is now an omnichannel powerhouse in programmatic advertising across desktop, mobile, audio, and CTV.
Magnite reported second-quarter results on Aug. 10 that reflected the impact of COVID-19, but management cheered investors with news that ad spending is bouncing back. Revenue grew 12% over the period a year ago to $42.3 million and would have been down 24% without the merger. But the trend improved in late May and June, and the company issued guidance for Q3 revenue of between $51 and $55 million, well above the consensus analyst estimate of $47 million.
The recovery may play out unevenly in coming months, and Magnite results will gradually improve as that happens, but the company's big bet on CTV is why long-term investors should be interested in this stock. CTV was only 19% of the company's Q2 revenue, but that business is growing 50% year over year in the current quarter as the pandemic accelerates the cord-cutting trend. Magnite is also gaining share as ad buyers seek out the largest players in sell-side advertising in order to reduce the number of vendors they work with and to become more efficient.
Even with recent gains, Magnite shares are still down 43% from their high, and this company's $814 million market capitalization is a fraction of buy-side ad powerhouse The Trade Desk's $21 billion valuation, despite being only one-fourth the size on a revenue basis.
Retail Opportunity Investments Corporation
Investors dumped shares of retail property landlords when the economy started shutting down, and this group of stocks has yet to rebound as much as retail stocks in general. The market's concerned that these businesses will have trouble collecting rent and keeping their properties leased, but that hasn't been a huge problem for Retail Opportunity Investments Corporation (ROIC), which specializes in shopping centers and strip malls in affluent locations on the West Coast.
Almost all of ROIC's shopping centers are anchored by groceries and drugstores -- essential businesses that didn't shut down. Even though 30% of the tenants of the real estate investment trust were forced to shut down at one point, only a handful were forced to close for good, and 87.5% were open when the company reported Q2 results on July 29. Currently, 97% of ROIC's properties are leased, just slightly less than its record 97.9% lease rate last year. By July 29, the company had collected 85% of the month's base rents, with some collections deferred on long-term agreements.
There's no doubt that retail struggles will continue to hurt the company's year-over-year comparisons, as it did in Q2 with 9.3% decrease in same-center net operating income. And the company is being cautious in continuing to suspend the dividend, which would be yielding 6.7% at today's share price, to conserve cash flow. But ROIC is well positioned to weather the pandemic storm. The resumption of normal business and a dividend payout will eventually boost the stock. Shares are not the remarkable bargain they were three months ago, but are still 38% below their 52-week high.
Zynex
For investors willing to take a little more speculative risk, oft-overlooked medical device company Zynex is worth considering, with soaring revenue driven by aggressive growth of a sales force to market its prescription electrical stimulation devices for pain management and rehabilitation.
Zynex's lead product is NexWave, a transcutaneous electrical nerve stimulation (TENS) device for pain management. The company markets the device as an alternative to opioids for treating acute and chronic pain from a wide variety of conditions, such as arthritis and sports injuries. Zynex also sells an electrical stimulation device for stroke recovery and received Food and Drug Administration (FDA) clearance earlier this year for a noninvasive blood monitor.
The company has a razor-and-blade business model that starts with a doctor's prescription, which the company counts as an order when it's filled, and continues as a revenue stream for months and even years as the company sells supplies for the device. Recurring revenue is 78% of the total, and the company had scorching top-line growth of 77% in the first half of the year. Orders in the first quarter soared 126% from the period a year ago, portending strong recurring revenue in coming quarters. Indeed, order levels were still up 37% in Q2 despite the effects of the pandemic on routine medical care. The company is profitable, too, with enviable gross margin of 79% and earnings of $0.09 per share in Q2, based on generally accepted accounting principles (GAAP).
What's responsible for the torrid growth? Well, the market for electrotherapy devices is growing at a robust pace, and the overall market for non-opioid pain treatments is enormous. But Zynex's supercharged growth is mostly coming from a massive expansion of its sales force. That move is proving to be just what the doctor ordered for the small, $580 million market cap company, but it's also a risk. Expenses are growing even more rapidly than revenue, and the plan depends on that sales force becoming productive.
Not every medical practitioner is convinced that TENS actually works; hence the need for a sales force to make the case. But so far, Zynex's results are speaking for themselves. With shares selling for 44% below their recent high and 29 times analyst estimates for earnings next year, this founder-led company is a good growth opportunity in healthcare for investors willing to take some risk.
