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3 Small-Cap Stocks with Big-Cap Potential

By Daniel Foelber - Apr 9, 2021 at 9:04AM

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Renewable energy and space exploration companies have room to run.

Unlike the large and well-known names that comprise the S&P 500 and Dow Jones Industrial Average, small-cap companies represent opportunities to be an early investor in an emerging business. The rise of $50 billion-and-higher IPOs and SPACs has flooded the market with higher-value names. But many of the largest companies in the world, like Amazon and Netflix, started out as small-cap companies.

Small-cap stocks are typically classified as having market caps under $2 billion. TPI Composites (TPIC 2.59%), Hannon Armstrong (HASI 3.19%), and Virgin Galactic (SPCE 2.01%) are a bit above that threshold, but are worth discussing as lesser-known names with growth potential. Here's what makes each a great buy now.

A row of Russian matryoshka dolls.

Image source: Getty Images.

1. TPI Composites

Valued at $2.1 billion, TPI Composites is an independent manufacturer of wind blades. After crashing 40% in just two weeks, the stock has mostly recovered from the sell-off as Wall Street went from sour to sweet on renewables. Even with the higher stock price, though, there's still a lot to like about TPI Composites for investors interested in wind energy.

TPI sells its wind blades to some of the world's leading wind energy original equipment manufacturers (OEMs) General Electric, Siemens, and Vestas under long-term supply agreements. As global demand for wind projects increases, these OEMs often find themselves operating in regions where they lack the capacity to manufacture their own blades. Wind projects take years to develop, and involve coordinating between several components and parts manufacturers. Anticipating a global rise in wind projects, TPI spent the last few years ramping up its global manufacturing capacity. It now has facilities in big-name markets like the U.S., Mexico, Turkey, China, and India. Its reach gives OEMs all the more reason to partner with TPI -- feasibility is a big deal when it comes to wind projects, and OEMs rely on companies like TPI to fulfill project specifications.

After a fantastic 2020 that saw record revenue, TPI is guiding for just a 7.8% increase in revenue this year. Lower revenue can be cause for concern, but TPI's guidance also called for lower spending and positive net income as the company begins to reap the benefits of its long-term investments. TPI's long-term success depends on sustaining and increasing orders with existing OEMs, as well as partnering with new OEMs in emerging markets. In the short term, the company is well-positioned to navigate a rising interest rate environment and achieve profitability before resuming its growth trajectory.

A wind blade manufacturing facility.

Image source: Getty Images.

2. Hannon Armstrong

With a market cap of $4.2 billion, Hannon Armstrong is much smaller than other well-known renewable energy stocks. But the company could be a big long-term winner. Hannon Armstrong is registered as a real estate investment trust (REIT). This means it doesn't pay federal income taxes as long as it distributes at least 90% of taxable income to shareholders.

Most renewable companies are either large utilities that fund and operate projects, OEMs that manage projects, or technology and parts manufacturers that supply hardware and software. Hannon Armstrong is in a unique position: It provides the capital that other companies need to do business. In this way, Hannon Armstrong is somewhat like a bank. Its $2.9 billion portfolio has a yield of 7.6%, consisting of 44% solar and 28% onshore wind projects, among other investments. Investments vary in scale and scope, but mainly include projects that reduce the energy consumption of buildings and systems, and large-scale infrastructure projects that generate power for the grid. For most of these projects, Hannon Armstrong acts as the debtholder, not the owner/operator. The holdings in its debt portfolio generate stable inflows and have an average term of 17 years. 

A row of wind turbines at sunrise.

Image source: Getty Images.

The company's business model is simple: Provide financing for renewable projects and distribute the vast majority of the profits to shareholders. With $1.10 in GAAP 2020 earnings per share (EPS) and $1.37 in dividends paid, it can seem as though Hannon Armstrong is funding its dividend with debt.

However, GAAP earnings don't take into account what the company calls "equity method investments". The accounting can get fairly complicated, but all you need to know is that Hannon Armstrong has preferred and common equity in certain projects. It adjusts its net income based on the performance of these projects and the forecasted return on capital. These adjustments can be significant: In 2020, they added $0.45 in EPS, giving the company $1.55 per share in what it calls distributable earnings. Distributable earnings are eligible for distribution to shareholders in the form of dividends.

Hannon Armstrong forecasts its distributable EPS will grow at a rate of between 7% and 10% per year from 2021 to 2023, and dividends per share will grow between 3% and 5%. With a dividend yield of 2.6%, Hannon Armstrong gives investors a respectable payout backed by a renewable portfolio that has grown, on average, 17% over the last five years. 

3. Virgin Galactic

After blasting past $60 a share, Virgin Galactic stock has come somewhat back down to Earth. Its shares are now around $30, giving it a market cap of roughly $7.2 billion.

Delays are the big reason for Virgin Galactic's sell-off -- namely its next test flight, which was moved from February to May 2021. Slowing growth and project delays are an unprofitable growth stock's worst enemy. Just ask Elon Musk, who spent years combating analysts and short-sellers fed up with Tesla's (TSLA 4.67%) production delays. Tesla eventually corrected its problems, and the rest is history. But people forget how rocky the situation was for a while, so much so that Elon Musk feared the company could go bankrupt. 

Virgin Galactic is even more unproven. Although it has built aircraft capable of taking passengers into space, it is still completing tests before it starts filling orders. Virgin Galactic continues to prioritize safety over scheduling, which is good for its long-term future. Consistently missing deadlines is a red flag, and the company needs to get better at setting realistic expectations. However, it's much better to be set back a few months than expose employees and passengers to unnecessary risks.

Virgin Galactic's WhiteKnightTwo aircraft.

Image source: Virgin Galactic.

Negligible revenue and a $273 million loss in 2020 seem off-putting. But Virgin Galactic has a first-mover's advantage in an industry that could be worth a pretty penny in the coming decades. Cathie Wood certainly thinks so. Her investment group, Ark Invest, owns Virgin Galactic in two of her six actively managed ETFs. Virgin Galactic is risky and is likely to be volatile in the coming years. But it's a moon shot with serious big-cap potential for investors willing to take on some risk.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Daniel Foelber owns shares of TPI Composites and has the following options: short April 2021 $55.0 puts on Hannon Armstrong Sustainable Infrastructure Capital, short August 2021 $50.0 puts on TPI Composites, short August 2021 $60.0 puts on TPI Composites, and short November 2021 $75.0 calls on TPI Composites. The Motley Fool owns shares of and recommends Amazon, Netflix, Tesla, and Virgin Galactic Holdings Inc. The Motley Fool recommends TPI Composites and recommends the following options: long January 2022 $1920.0 calls on Amazon and short January 2022 $1940.0 calls on Amazon. The Motley Fool has a disclosure policy.

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Stocks Mentioned

TPI Composites Stock Quote
TPI Composites
$24.55 (2.59%) $0.62
General Electric Company Stock Quote
General Electric Company
$79.93 (1.30%) $1.03
Netflix, Inc. Stock Quote
Netflix, Inc.
$249.30 (2.72%) $6.60, Inc. Stock Quote, Inc.
$143.55 (2.07%) $2.91
Tesla, Inc. Stock Quote
Tesla, Inc.
$900.09 (4.67%) $40.20
Siemens Aktiengesellschaft Stock Quote
Siemens Aktiengesellschaft
$57.81 (2.26%) $1.28
Vestas Wind Systems Stock Quote
Vestas Wind Systems
$8.86 (-2.21%) $0.20
Hannon Armstrong Sustainable Infrastructure Capital, Inc. Stock Quote
Hannon Armstrong Sustainable Infrastructure Capital, Inc.
$44.29 (3.19%) $1.37
Virgin Galactic Holdings, Inc. Stock Quote
Virgin Galactic Holdings, Inc.
$7.12 (2.01%) $0.14

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

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