Small-cap stocks, generally defined as businesses with market caps between $300 million and $2 billion, offer high potential upside to investors but are often more volatile than your average stock.
These securities are generally not as safe or durable as mega-cap corporations like Microsoft or Berkshire Hathaway. However, the small-cap Russell 2000 Index has outperformed its large-cap S&P 500 counterpart over the last 40 years, which shows the opportunities that exist among these companies.
Two small-cap stocks investors should look at in May are Planet 13 Holdings (PLNH.F 1.22%) and Aterian (ATER 6.11%). Here's why.
Image source: Getty Images.
1. Planet 13 Holdings
Planet 13 is a retail cannabis concept based in Las Vegas. It only owns two stores, but one of them, its Las Vegas Superstore, is one of the largest -- if not the largest -- cannabis dispensaries in the world. The 112,000-square-foot entertainment complex offers all types of cannabis products and experiences, including educational tours, restaurants, and events. Planet 13 markets the superstore, located near the Las Vegas Strip, as a tourist destination for anyone interested in a full-blown cannabis experience.
So far, even with COVID-19 headwinds, the strategy is paying off. In 2020, Planet 13 generated $70.5 million in sales, the majority of which came from the Vegas superstore. While impressive, $70 million in sales understates the true revenue potential of the superstore.
Planet 13 reported that, in March, the company generated $9.7 million in sales, and that it expects revenue to continue accelerating once the economy reopens fully. Extrapolating from March's monthly sales, it looks like the Vegas Planet 13 location is on pace to do over $100 million in revenue this year.
After Vegas, Planet 13 has ambitions to bring the cannabis superstore concept to as many major North American markets as possible. The next location will be in Orange County, California, and will try to replicate the Vegas superstore experience. The location is only 55,000 square feet and is in a city not solely based on tourism, so don't expect it to hit $100 million in annual sales anytime soon, if ever. But it is an important step for Planet 13 to prove its concept can work in different cities, not just in a unique area like Las Vegas.
With a market cap of $1.34 billion, it looks like investors are expecting Planet 13 will be able to expand its superstore concept across America over the next decade (in states where cannabis is legal, of course). If Planet 13 is successful in replicating its Nevada strategy, a current market cap of $1.34 billion will look a lot more reasonable five or 10 years from now.
2. Aterian (formerly Mohawk Group)
Aterian, which was called Mohawk Group until a few days ago (it will also be changing its stock ticker to ATER), is a small conglomerate of online consumer brands that optimizes for selling products on Amazon and other e-commerce platforms. It has a data-driven approach using its AIMEE operating engine to optimize selling performance. Essentially, Aterian buys and develops products and then uses AIMEE to give the products an advantage in optimizing for digital placement, search results, and reviews on Amazon.
When Aterian buys a brand, it can greatly improve profit margins by consolidating overhead costs at the parent company. This means that even though Aterian may acquire a brand or company at five or 10 times its annual operating income, once it is integrated into the AIMEE system, the acquisition earnings multiple may head down to three or lower without any additional top-line growth.
At a market cap of $591 million, Aterian trades at a price-to-sales ratio (P/S) of 3.2. If the company hits the low end of its 2021 guidance of $350 million in revenue and $30 million in EBITDA, it will have a P/S of 1.7 and price-to-earnings (P/E) of around 19.7.
While these metrics look reasonable for a company like Aterian with a proven model and a long runway for growth, investors need to remember that when it makes acquisitions, Aterian sometimes uses stock, which dilutes existing shareholders and raises its valuation. This doesn't mean that Aterian will be a bad investment, but share dilution will be a headwind as it continually adds more consumer brands to its portfolio.
Investor takeaway
Both Planet 13 Holdings and Aterian, like many small-cap stocks, could trounce the market over the next decade if they execute their respective growth strategies. But investors need to remember that small-cap stocks also bring a higher risk of downside and volatility to the table. With that in consideration, if you are an investor who can stomach the high volatility of small-cap investing, you should take a hard look at Planet 13 Holdings and Aterian.
