A new bull market is emerging from all of the chaos in 2020, and investing in small companies benefiting from structural changes to the economy can lead to big returns in the years to come.
Just remember to keep new positions small (I usually start with less than 1% of my portfolio), purchase more shares over time (perhaps monthly or quarterly), and stay focused on the company's long-term potential (no less than a few years).
Three small-cap stocks that look attractive right now are Bandwidth (BAND -3.63%), Vroom (VRM -1.71%), and LiveRamp (RAMP -1.14%). Let's find out a bit more about each of these companies.
1. Bandwidth: If you think you missed the boat on cloud communication stocks...
Stocks like Zoom Video Communications (ZM -0.99%) and Twilio (TWLO -1.59%) have been some of the hottest stocks around this year, and are sporting triple-digit share price increases. With the world going on lockdown back in March and social distancing protocols looking like a normal part of life for the foreseeable future, cloud-based communications services have been in high demand.
Image source: Getty Images.
But if you think you missed the boat here, don't fret. Bandwidth operates in the same space as Twilio, offering developers a set of applications to embed voice, messaging, and 911 access into their services. In fact, Bandwidth counts Zoom among its customers, as well as Microsoft, Alphabet's Google, and RingCentral. It also just acquired former peer Voxbone, giving it access to more than 60 countries.
Why look at Bandwidth now? It has also surged triple-digit percentages this year, up nearly 160% year-to-date as of this writing. But this is still a very small company, with a market cap of just $4 billion (compared to Twilio's $49 billion). And it trades for just 14 times trailing 12-month revenue (to Twilio's 28 times revenue). And while it isn't growing as fast as Twilio, it isn't too far off, with sales growth of 35% through the first nine months of 2020 compared with the same period in 2019.
Cloud-based communications services will be a fast-expanding industry over the next decade, with organizations switching off legacy services in lieu of higher-tech ones. Annual spending on cloud messaging and voice is already homing in on $20 billion a year by some estimates, and it is expected to grow exponentially from there. Twilio is the leader in this space, and even other companies like Microsoft have picked up on the trend and are trying to get a slice of the pie -- but there will be plenty of room for multiple companies to win. I think Bandwidth will be one of them.
2. Vroom: Demand for cars is riding high
I usually steer clear of hot IPO stocks until after a quarter or two of results. Sometimes I miss out on some stellar returns, but more often than not I get in at more attractive prices by being patient. Just such a situation may have presented itself with Vroom.
Digital car retailer Vroom priced its IPO at $22 a share back in June, but the price more than doubled when it started publicly trading. And the race higher only continued from there. But after the company's Q2 2020 report and the subsequent sale of more stock (proceeds of which may have raised an additional $600 million or so in cash), share prices have fallen back to $42 a share as of this writing.
The culprit? E-commerce revenue grew "only" 45% year over year in Q2, slowing the first-half 2020 growth rate down to 94% compared to 2019. Even more concerning was management's outlook for overall revenue to fall in Q3, driven by slower sales growth in the company's e-commerce unit and a drop in average car selling prices. But I think with the recent tumble most of the uncertainty Vroom was anticipating during the summer months is already baked into the share price. After all, recent data from the U.S. Census Bureau shows that car sales have steadily rebounded in recent months. I wouldn't be shocked if Vroom surprises investors with a better-than-forecast report when it releases Q3 results on Wednesday, Nov. 11.
Longer-term, the real story here is a steady migration from traditional retail to online, and this trend should work in Vroom's favor over time -- even if the balance of 2020 remains less than ideal for this used car dealer. And though growth is very much a necessity to help this small company (with a current market cap of $5 billion) erase the $60.5 million net loss racked up so far this year, it should have about $1 billion or more in cash on its balance sheet after Q3, and no debt. At just 2.9 times trailing 12-month sales, this digital car dealer looks like a reasonable bet to me right now.
3. LiveRamp: A better way to bet on digital data?
I'm circling back around to LiveRamp ahead of its next quarterly update on Monday, Nov. 9. This small digital data stock has been steadily growing since I first purchased it over the summer, and I'm sitting on a 50% gain since then. But recent events make me optimistic this run will continue for some time.
First, there are the antitrust reviews taking place at big tech companies like Facebook and Google, including the lawsuit recently filed by the Department of Justice against Google. Paired with ongoing concerns over internet user privacy and data practices, I think this will create long-term demand for LiveRamp's third-party digital data aggregation platform.
Additionally, the economy continues to adapt to the new digital age emerging from the COVID-19 crisis. Besides a general thawing of corporate budgets on things like advertising during the spring and early summer months, LiveRamp will benefit as an increasing number of businesses look for new ways to reach their target audiences. The internet is how they'll do that. And rather than try to accumulate data on potential customers directly, an anonymous cross-section of information like what LiveRamp provides looks like it will find plenty of use. A loosening of the digital data duopoly would certainly help the cause.
This is no cheap stock at 12 times trailing 12-month revenue. However, 21% sales growth in the last quarter, a still-improving 65% gross profit margin on services rendered, and $650 million in cash -- and zero debt -- are reason enough for the premium. There's a lot of promise in the years ahead for LiveRamp, so I've continued buying this small stock (current market cap of $4.7 billion) ahead of the next quarterly update.
