My dad is good at a lot of things. He's a national leader in public archeology, he can fix most things around the house, he is a master at the grill, and he's perfectly happy to get on the floor and play with his grandchildren for hours.
But he's not much into the financial markets. Never was.
Too bad
If he had had the foresight to make some smart investments in small-cap companies back when I was still in diapers, some of those could very well be large caps today, and he could be paying for his grandchildren's college educations -- if, for some reason, they don't all get full rides.
Because the simple fact is that today's big companies weren't always big companies. Costco, Geico, and an array of other big-name companies were small caps in the days before I started wheeling around on my tricycle. The perpetual go-to example, Wal-Mart (NYSE:WMT), was a cute little outfit run by some hillbillies in Arkansas, according to Wall Streeters.
Today, Wal-Mart's employees outnumber most nations' armies and some counties have legislation in place to require citizens to make a weekly trip to the store.
Tomorrow's big companies are out there now, masquerading as small companies.
Looking back, looking ahead
Sure, it's nice to be able to grab examples like that after the fact. Predicting the past requires no special talents.
But there are definitive signs to look for that will help you make these decisions before they happen. Hidden Gems advisor Tom Gardner looks for the following traits, which he laid out in his article "The Next Home Run Stock":
- Founders with large personal stakes.
- Financial statements that are easy to read.
- A solid asset base with little or no debt.
- Price ratios that significantly undershoot growth rates of free cash flow.
- Dominant positioning in a profitable niche.
- Plenty of room to grow.
It's the last two that are of particular interest to me, as a father of a handful of toddlers who might be looking for help with funding their kids' college tuitions. I want to find small caps that look like 2026's large caps.
What looks promising right now?
One that jumps out from the Hidden Gems scorecard is II-VI (NASDAQ:IIVI), a high-tech business focused on manufacturing and marketing the parts needed to operate lasers and infrared optics systems. The applications are already fairly broad-based, with customers ranging from Ford (NYSE:F), which uses lasers in its own manufacturing processes, to defense contractors such as Raytheon (NYSE:RTN), which use lasers in their targeting and imaging systems. Recent acquisitions have allowed II-VI to expand its niche, but there's still room to grow, and II-VI is well-positioned to be a force in whatever this sector becomes.
A quick scan of five-star stocks in our Motley Fool CAPS database shows dozens of other companies that are sitting pretty in their niches and have room to grow. That includes Hidden Gems-recommended energy plays such as Dawson Geophysical (NASDAQ:DWSN) and OYO Geospace (NASDAQ:OYOG), which make money not from sustained high prices but from more predictably sustained demand. There's also potential in a small biotech like BioMarin Pharmaceuticals (NASDAQ:BMRN), which is looking to solve genetic disorders.
A Foolish future
By picking tomorrow's big companies before they hit their growth spurts, I'm ensuring no one will panic when all of my grandchildren decide to go to exclusive, out-of-state private schools.
If you're interested in finding some of our favorite small-cap companies, here's a thought: Try a full-access, 30-day free trial to Hidden Gems and see our full list of recommendations, which are beating the market by more than 24 percentage points since inception.
Roger Friedman is the managing editor of multiple newsletters and the author of Nipple Confusion, Uncoordinated Pooping and Spittle: The Life of a Newborn's Father . He owns shares of Ford. Wal-Mart is a Motley Fool Inside Value recommendation. Costco is a Motley Fool Stock Advisor recommendation. The Motley Fool isinvestors writing for investors.
