Investing on Wall Street comes with its inevitable ups and downs. Since this decade began, the iconic Dow Jones Industrial Average, broad-based S&P 500, and innovation-driven Nasdaq Composite have fluctuated repeatedly between bull and bear markets.
For short-term traders, these wild vacillations can be unnerving. But for long-term investors, volatility begets opportunity. With small-cap stocks vastly underperforming megacap companies of late, values abound for patient investors willing to look for them.
What follows are three small-cap stocks that have the ability to generate life-changing wealth for investors over the next 20 years.
Image source: Getty Images.
PubMatic
The first small-cap stock that can produce life-altering wealth for patient investors is adtech company PubMatic (PUBM 1.75%).
The biggest headwind at the moment for PubMatic is the health of the U.S. economy. Although select datapoints show the economy continues to motor along, a couple of money-based metrics are signaling trouble ahead. Advertisers tend to pare back their spending at the first signs of trouble, which have adversely impacted PubMatic's top-and-bottom-line results.
But this is a two-sided coin that undeniably favors long-term-minded investors. Though recessions are an inevitable part of the economic cycle, they're over relatively quickly. No recessions following World War II have lasted longer than 18 months, and only three hit the 12-month mark. Comparatively, most expansions extend multiple years. Advertising-driven businesses like PubMatic are able to take advantage of these long-winded periods of growth for the U.S. and global economy.
PubMatic finds itself at the center of the fastest growing trend within the ad industry: digital advertising. More specifically, it's expecting double-digit annualized growth from connected TV, video, and mobile advertising through at least mid-decade if not well beyond.
The interesting thing about PubMatic is that it's a sell-side platform (SSP) in the programmatic ad space. Because of ongoing consolidation in the SSP arena, there aren't too many respected companies left where publishers can sell their digital display space. As a result of decreasing competition, PubMatic's share of the sell-side programmatic ad space has grown to 4% to 4.5%.
What's arguably the most attractive aspect of this company is its cloud-based programmatic ad platform. Instead of relying on a third-party service, PubMatic wisely decided to build out its own infrastructure. With the company's sales expected to grow by double digits on an annualized basis over the long run, it'll be able to keep more of its revenue as it scales. In other words, this decision is a recipe for a substantially higher operating margin.
The final reason long-term investors can trust PubMatic is the company's balance sheet. PubMatic closed out the September-ended quarter with $171.4 million in cash, cash equivalents, and marketable securities, with no debt, and it's been generating positive cash flow for nine years. It's perfectly positioned to succeed in any economic climate.
Lovesac
A second small-cap stock with the potential to create life-changing wealth for investors over the coming two decades is furniture retailer Lovesac (LOVE -0.05%).
If your immediate instinct when hearing "furniture retailer" is to fall asleep, you're not alone. The furniture industry is typically slow growing, highly dependent on foot traffic into physical stores, and often struggles to differentiate its products. Lovesac is nothing like the traditionally stodgy furniture industry.
Without question, the biggest difference between Lovesac and its competition is its furniture. Though it was originally well-known for its beanbag-styled chairs known as "sacs," approximately 90% of its net sales can now be traced to "sactionals" -- modular couches that can be rearranged to fit most living spaces.
Sactionals come with over 200 different cover choices; the yarn used in their production is entirely derived from recycled plastic water bottles; and there is no shortage of upgrade options, including wireless charging stations. The point being that sactionals are unique in their functionality, optionality, and eco-friendliness.
You might be thinking that all of these extras would be costlier for consumers, and you're correct. But this is a conscious move by Lovesac and its management team. Targeting a higher-earning clientele that's less likely to change their spending habits during minor economic downturns should help Lovesac weather inevitable storms.
Another reason Lovesac has been running circles around its competition is its omnichannel sales platform. During the COVID-19 pandemic, Lovesac successfully shifted a significant portion of its sales online. It's also relied on pop-up showrooms and partnerships with brand-name businesses (e.g., Best Buy and Costco Wholesale) to increase brand recognition and move its products. This approach has led to meaningfully lower overhead than brick-and-mortar retailers and a superior operating margin.
Lovesac's innovation and omnichannel sales approach should generate sustained double-digit revenue and profit growth over the long run.
Image source: Getty Images.
Fiverr International
The third small-cap stock that can generate life-changing wealth over the next 20 years is online-services marketplace Fiverr International (FVRR 3.74%).
Fiverr is facing a lot of the same short-term challenges PubMatic is contending with, such as worries about the U.S. economy. When recessions occur, it's pretty normal for the U.S. unemployment rate to rise. The prospect of a weaker jobs market could make businesses less willing to spend on freelancer services.
But while recessions are inevitable, they're also short-lived. This makes downside-stoked fear the ideal opportunity for patient investors to pounce on industry-leading businesses like Fiverr.
Whereas the COVID-19 pandemic was challenging for most companies, it represented a moment of permanent opportunity for Fiverr. Even though some workers have headed back to the office with the worst of the pandemic in the rearview mirror, more workers are remaining remote (either full- or part-time) than ever before. A remote, mobile labor force plays right into Fiverr's gig economy-driven operating model.
What's even more important is that Fiverr's platform has differentiated itself from its rivals. While most of the company's competing online-services marketplaces have freelancers pricing their tasks on an hourly basis, Fiverr's freelancers are listing their jobs at one price for a completed project. The price transparency that Fiverr can offer businesses is unsurpassed, and it likely explains why spend per buyer has been climbing on a fairly steady basis.
But the most important aspect of Fiverr's operating model is its take rate, i.e., the percentage of each deal negotiated on its platform that it gets to keep, including fees. During the September-ended quarter, Fiverr's take rate expanded to 31.3%, which is nearly double that of its key competitors. What this tells investors is that Fiverr is continuing to take a greater share of total transactions on its platform, yet it's not driving away buyers or the freelancers that make its business tick. If Fiverr can sustain this steady expansion of its take rate, it should have no trouble outpacing its peers in the margin department.
Fiverr's historically cheap valuation is the cherry on the sundae for investors waiting to dig in. After its stock completely round-tripped over the past four years, shares can be purchased for roughly 10 times forward-year earnings. With long-term, double-digit growth potential, you'll likely never see Fiverr this cheap again.
