Unlike individual investors, who don't have to meet yearly performance targets and can buy whatever stocks they like, some professional fund managers are restricted to only buying bigger companies. For example, the top 300 stocks or those included in the S&P/ASX200 Index (ASX: XJO) (INDEX: ^AXJO).
Unfortunately, that makes it harder to find compelling undervaluation in the stocks they analyse, since all they are usually well covered by other analysts and money managers. Whilst there's no denying companies such as Telstra Corporation Ltd (ASX: TLS), Commonwealth Bank of Australia (ASX: CBA) and Woolworths Limited (ASX: WOW) have significant long-term potential, their current share prices and sheer size makes it very difficult for them to become multi-baggers. That is, those stocks which more than double in value while you hold them.
With an increased market place, individual investors like you and me can go about our business with a number of advantages over the pros. I am particularly fond of companies with market capitalisations between $100 million and $500 million. Although they may be perceived as more "risky" than their blue-chip counterparts, the rewards can far outweigh the risks.
Here are three small-caps which should definitely be on your watchlist and perhaps even in your long-term portfolio (they're in mine!).
1. Cash Converters International Ltd (ASX: CCV) is still one of my favourite buy ideas for new money. Even though the stock has risen 25% in the past six months (after falling steeply due to legislative changes on small loan fees), at $1.11, I think it's a great long-term buy to hold company.
2. Shine Corporate Ltd (ASX: SHJ) is a junior law firm which is busy expanding its presence throughout Australia and outside its most lucrative market of Personal Injury (PI). Following in the footsteps of Slater & Gordon Limited (ASX: SGH), Shine has significant long-term potential. Investors should note however that shares in the stock can sometimes be very illiquid due to two managers' substantial holdings.
3. Yellow Brick Road Holdings Ltd (ASX: YBR) is a $144 million diversified financial business which is run by former Wizard Home Loans founder, Mark Bouris. Although currently unprofitable, management are aggressively taking advantage of the low interest rate environment to drive sales of financial products through its growing store network. I expect it'll produce its maiden profit in FY15 or FY16.
The BEST dividend small-cap stock on the market
I believe each of these businesses hold promise in the long term. Unlike some fund managers, we don't have restrictions on the companies we can buy, so use it to your advantage by discovering undervalued small-cap stocks before they do, and hold them for the long term!
It's important to remember that sometimes there can be one noticeable disadvantage to buying stocks of this size: dividend yields. Although they intend to pay great dividends in the future, many small-caps lack the cash flows of blue-chip stocks like those above.
