Small-cap stocks -- companies with a market capitalization of roughly between $300 million and $2 billion -- offer investors a way to increase the upside of their portfolios by owning smaller companies that have a chance to grow into the next big success story. Picking the next small-cap winner is easier said than done, of course, and many of us reading this probably wish we could go back and jump on some of today's highflying tech stocks before they began their phenomenal rise. But finding one big winner and holding for the long term can provide a big boost to your portfolio returns.
Here are two small-cap stocks on my watch list that have intriguing growth strategies that could turn them into bigger winners down the line.
BJ's Restaurants (NASDAQ:BJRI)
BJ's Restaurants is a high-quality "casual plus" chain of 158 restaurants in 19 states. The restaurants serve a plethora of craft beers with a diversified menu of food that has multiple signature dishes. The driving force behind BJ's Restaurants becoming a future winner is serving up consumers a $20 to $25 experience (according to the company) for an average check of approximately $14 -- an experience and value that should bring consumers back. Also, as a small-cap stock, BJ's Restaurants' market penetration is still in its early stages.
Another pillar of BJ's Restaurants' growth story will be making each location more efficient by controlling costs and updating the menu. It delivered new deep-dish pizzas, new tavern-cut pizza, quinoa bowls, and new entrees in recent months, with an ever-changing list of seasonal IPA beers that capitalize on the surge in craft-beer popularity. BJ's is also optimizing its restaurants with a new prototype 7,000-square-foot store, which is about a 20% reduction from many of the larger locations and will reduce the investment cost by $1 million per new store.
While the company hit a speed bump with declining margins a couple of years ago, it appears management has figured things out, and margins have since rebounded from their 2013 lows. This is a trend that should continue as management continues to take action on up to 800 "Project Q" ideas -- ideas from restaurant managers that focus on improving kitchen productivity, menu optimization, food quality, and food sourcing decisions. So far, 300 have been implemented, and by implementing more of these ideas, it could further boost margins.
BJ's Restaurants plans to open 15 new restaurants in fiscal 2015, and if management continues to reduce costs and deliver high value compared to its average check, this could be a real winner as it strives to grow from 158 stores to more than 400.
Next up: Sonic Automotive (NYSE:SAH). While original equipment automotive manufacturers are plagued with capital-intensive factories and high labor costs, auto dealerships are typically well-diversified businesses that don't face such lofty up-front costs. Dealership groups are also hit less hard during recessions, because many, such as Sonic Automotive, have very profitable parts and servicing operations. Furthermore, dealership groups such as Sonic Automotive don't have to rely on an single brand or manufacturer for sales success.
Sonic Automotive's growth story revolves around an increased focus on selling more lucrative new luxury and import vehicles. The company plans to open a Mercedes-Benz dealership in the Dallas market and an Audi dealership in the Pensacola, Florida, market -- with both set to be operational in 2016. Sonic Automotive is also focusing on getting its foot in the door of used-car sales, which would aim to take market share from successful used-car dealers.
The strategy to grab some of the lucrative used-car sales pie is a new one for Sonic Automotive. It initially opened three dealerships, under the EchoPark brand, but aims to eventually have 100 stores coast to coast to rival competitor CarMax's current 140-plus store count in the U.S. market.
While Sonic Automotive reached a milestone with an average 100 used-car sales per store in its second quarter of 2015, that's still less than a third of what CarMax averages. Furthermore, Sonic Automotive doesn't expect its EchoPark strategy to be profitable until 2018 -- but if management can successfully execute this strategy, it will provide meaningful top- and bottom-line growth to go with increasing sales of new and luxury vehicles. It's a growth story that will take time to play out, but that's part of the patience required from investors when buying into a small-cap stock.