Many investors are afraid of investing in small-cap stocks, believing that the heightened risk of smaller companies increases the chances that they'll suffer major losses. But the best small caps offer huge growth potential, and shares can often vault from single-digit prices to produce impressive long-term returns for buy-and-hold investors.
To give you some ideas on which small caps might deserve at least some attention, we turned to three Motley Fool contributors to talk about some companies they've been watching. Read what they have to say, and see if you agree with their investment theses, or have a different opinion.
Selena Maranjian: A small cap I've got my own eye on is Threshold Pharmaceuticals (Nasdaq: THLD), a biotech company developing treatments to fight cancer. It's not without risks, as it's been operating at a loss for the past decade. In its last quarter, for example, it lost $6 million. But then it's the nature of many smaller biotech companies to be operating in the red for years while developing many drugs, one or more of which will eventually make it all worthwhile.
The company and its investors are pinning much hope on its hypoxia-targeted therapy TH-302, which represents a new way to fight cancer. It focuses its cancer-attacking properties on cells that are hypoxic -- low on oxygen, often due to tumor growth. Thus, it can do less damage to healthy parts of the body. TH-302 is involved in about 10 clinical studies, targeting non-squamous non-small cell lung cancer, soft tissue sarcoma, kidney cancer, liver cancer, and among other cancers, pancreatic cancer -- where in one study, it improved progression-free survival by 2.4 months. Most of its trials are early stage, but the soft-tissue sarcoma and pancreatic cancer trials are in Phase 3.
Threshold's stock has averaged annual growth of 20% during the past five years. It's hard to estimate where it might be in the future, as everything depends on the success of its treatments. But if one or two win FDA approval, the stock may leave today's price in the dust. In the meantime, expect the stock to drop on any disappointing news. Threshold is not a stock for risk-averse investors; but for the right investors, it's worth considering.
Todd Campbell: Although there's a lot of risk associated with buying any sub-$10 stock, there are some companies where the reward may justify taking a gamble and going long. Orexigen Therapeutics (NASDAQ:OREX) could be one of them.
Orexigen won FDA approval for its weight-loss drug Contrave last fall, and in its first full quarter on the market, its sales totaled $6.5 million. That's far from a blockbuster launch, but it stacks up pretty favorably against its competitors. For example, despite having a two year head start, Arena Pharmaceuticals' (NASDAQ:ARNA) Belviq, which won FDA approval in 2012, had $10 million in sales during the fourth quarter.
In addition to a relatively solid start, Orexigen recently reported that interim trial results from a cardiovascular safety trial may indicate that Contrave can reduce the likelihood of major cardiac events, such as heart attacks. The revelation surprised investors (and drew the FDA's ire) because the study was designed to show that Contrave didn't increase the risk, not to prove that it lowered it. Regardless, if the interim results pan out over time, an improved cardiac profile could give it an edge in winning scripts in a market that should continue to grow. According to the CDC, 34.9% of Americans are obese, so there is a significant need for new weight-busting solutions.
Dan Caplinger: Most investors like small-cap stocks because of their youth rather than because of a calamity; as a result, mortgage- and bond-insurance specialist MBIA (NYSE:MBI) doesn't jump to the front of most investors' radar screens. The company used to be a large-cap giant in its field, playing a key role during the housing boom in providing insurance for homebuyers in order to secure mortgage financing from banks and other lenders. When the housing market collapsed, MBIA went to the brink of failure; but it has survived and almost quadrupled from its 2009 lows.
More recently, some investors have become worried about MBIA's exposure to another financial market. In addition to mortgage insurance, MBIA also has provided insurance on municipal bonds, and the challenges faced in the Puerto Rican municipal-debt market has stoked fear of another potential crisis that could hit the bond insurer hard.
Investors do face some risk with MBIA; but with the company's share price equal to less than half its book value per share, shareholders are already getting a sizable margin of safety against the exposure that MBIA has to any future worsening of conditions in Puerto Rico. MBIA is a bit big for a true small cap, but it has the potential to recover even further if it can keep navigating the financial markets well.