Most every growth investor is looking for that small company today that brings massive returns. Such powerhouses do have to start from somewhere, after all -- Amazon and Netflix once had market caps under $1 billion.
Recognizing those future winners when they are still in the small-cap phase is extremely challenging. However, they can be a bit easier to spot once they've become mid-cap stocks, with market caps in the $2 billion to $10 billion range. Obviously, nobody can guarantee any such company will lead its industry segment or become a multi-bagger. But in the views of three Motley Fool contributors, these three companies have forged paths that could take them to such a level.
Already growing by leaps and bounds, Duolingo could one day be the world's learning platform
Jake Lerch (Duolingo): OK, let me be clear: For language-learning platform Duolingo to deliver truly massive returns, it needs to grow -- a lot. Right now, Duolingo's (DUOL +1.15%) market cap is $6.5 billion. Even if it quadrupled its market cap to $26 billion, it would still be only about a tenth the size of a more established tech stock like Netflix.
NASDAQ: DUOL
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To get growing, Duolingo will have to put the pedal to the metal on numerous fronts. Let's start with the obvious one: It must increase its revenue stream, which can happen in part by growing the app's paid subscriber base. Thus far, this is going well: Paid subscribers grew by 63% year-over-year at the end of the first quarter of fiscal 2023, up to 4.8 million.
Selling more in-app features will also contribute to revenue growth, and there's been progress on this front as well. Total bookings jumped 37% in the same year-over-year period, bringing in $140.1 million in the latest quarter. But, this growth can only continue if Duolingo sees a jump in users.
As of Q1 in fiscal 2023, Duolingo has 72.6 million monthly active users (MAUs). That's up 47% year-over-year. However, that number will need to snowball for Duolingo to take things to the next level.
Thankfully for the company, many people have not heard of Duolingo, let alone tried its product, meaning that the company has an impressive growth runway. As more people engage with artificial intelligence (AI) chatbots like ChatGPT, the appeal of Duolingo's AI-driven learning app should increase.
What's more, nothing is stopping Duolingo from branching out beyond language learning. The company's mission statement notes its goal is to "develop the best education in the world" -- not just language education, all education.
Suppose the company can ramp up its user base and revenue by developing state-of-the-art education software that uses advanced AI. In that case, Duolingo could become the leading learning platform worldwide, bringing pretty payoffs to early investors in the process.
A $45 trillion market with limited competition? Yes, please.
Justin Pope (Opendoor Technologies): Buying and selling a home is arguably the most important transaction in most people's lives, but it's also notoriously stressful. The general homebuying process hasn't changed much in many decades, but Opendoor (OPEN 2.28%) wants to bring homebuying into the 21st century. It pioneered iBuying, in which companies buy homes from consumers and resell them on the market. Opendoor offers convenience and speed for sellers and charges less than traditional real estate agents.
The market opportunity is enormous. U.S. homes are worth $45 trillion in total, and the inventory is always slowly turning over as people move. Opendoor currently handles just a tiny sliver of that market, generating $13.5 billion in revenue over the past year. There's clearly room for expansion. It's not a risk-free investment; Opendoor leans into small gross margins because you can't rip people off with super profitable home offers and expect to close many deals. However, getting your pricing wrong can have catastrophic consequences. Opendoor tried expanding too quickly and incorrectly priced many homes as the market cooled in early 2022, losing hundreds of millions of dollars in inventory write-downs.
NASDAQ: OPEN
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But after replacing the CEO with former CFO Carrie Wheeler, the company has recovered from this misstep and is trending back in the right direction. The rugged housing market forced competitor Redfin out of the iBuying game, and in August 2022, Opendoor joined forces with former iBuying competitor Zillow in a partnership that's still rolling out and could boost its business.
The company currently has a market value of just $3 billion. Even if iBuying isn't the future of all homebuying, the addressable market is large enough that Opendoor could be a niche business within its industry and still grow to multiple times its current size. The company must still make a consistent profit, making Opendoor a more speculative investment idea today. However, owning just a little piece of this company could pay off big if Opendoor can execute and realize its full potential.
The small-business cloud stock headed for smooth waters
Will Healy (DigitalOcean): Admittedly, DigitalOcean (DOCN 4.80%) may seem like a poor choice from a size perspective. At a market cap of just over $4 billion, it competes with companies like Amazon, Microsoft, and other cloud giants that have market caps more than 200 times greater.
However, it has leveraged its smaller size to offer its customers two key competitive advantages.
For one, it posts all of its prices online. This creates a simple interface where small and medium-sized businesses (SMBs) can purchase only the cloud services they need. Taking this approach will probably induce many SMBs to choose DigitalOcean, keeping their costs low.
Secondly, the DigitalOcean community is a key asset. If a customer has an IT-related issue, that community offers a vast documentation library. Customers may also turn to other members of DigitalOcean's customer base who could offer a resolution. This is critical because many DigitalOcean clients may have one-person IT departments or even rely on a single employee who's already juggling other tasks within the enterprise. The community makes it more likely a company can resolve IT-related issues in a cost-effective manner.
Through such customers, DigitalOcean believes its total addressable market will reach $195 billion by 2026, a compound annual growth rate of 26%. Its revenues now give it a less than 1% slice of that potential market. In the first quarter of 2023, its revenue was $165 million, up 30% from the same quarter last year.
Indeed, it lost $35 million in Q1 as stock-based compensation, restructuring costs, and other expenses weighed on its bottom line. But its non-GAAP net income of $29 million more than tripled from year-ago levels.
Additionally, the company estimates 2023 revenue of $710 million at the midpoint, which would be a 23% increase from 2022. If it maintains that pace, it could reach GAAP profitability in the foreseeable future.
NYSE: DOCN
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Furthermore, the stock is up by over 95% year to date. And even with that significant increase, it likely remains attractive with a price-to-sales ratio of 8, especially when considering DigitalOcean's massive addressable market. As more SMBs turn to DigitalOcean's service offerings, this cloud company could eventually drive outsized returns.
