It is well known small-cap stocks are under-researched by large institutional investors and risk-averse retail fund managers.
Fortunately, the lack of coverage can present compelling opportunities for savvy investors. Other reasons why small shares offer better returns than their larger counterparts in the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) include:
- Over-selling, which results from large institutions being forced sellers due to their investment mandates.
- Smaller companies have more room to grow; and
- Speculation runs rife on illiquid stocks
3 small-cap stocks trouncing the S&P/ASX 200
I prefer to buy businesses that are nearing profitability, generate free cash flow and have favourable long-term tailwinds. However, my rules are not hard and fast — I'm willing to bend them from time-to-time.
Here are three small-cap stocks I've bought and recommended in 2015, for one or more of the reasons above.
- Bulletproof Group Ltd (ASX: BPF) – Year-to-date return: 28%
Bulletproof is a leading managed cloud services provider that is founder led and has significant insider ownership. Bulletproof offers clients the ability to take their technology and applications from standalone servers to the cloud, using Amazon Web Services or VMware. It's profitable and my discounted cash flow analysis values Bulletproof shares around $0.59.
- Senetas Corporation Limited (ASX: SEN – Year-to-date return: 209%
Senetas shares have rallied 70% since I recommended them in May. The company builds high-speed encryption devices for Fibre Optic and Ethernet communication networks. Operating out of Melbourne, Senetas' certified range of devices are sold to security organisations, government departments and private enterprise via its own local channels and an international distribution agreement with Gemalto. The defensive revenues of Senetas continue to be bolstered by increasing maintenance contracts. At 16.7 cents per share, I think Senetas is near fair value but could surprise to the upside over coming years.
- Reffind Ltd (ASX: RFN) – Year-to-date return: 870%
Reffind shares have soared almost 900% since listing on the ASX in July, and 180% since I recommended them in September. Run by an experienced management team, with Jamie Pride at its helm as CEO; Reffind is arguably the most speculative of the three businesses on this list. While Reffind's management previously stated its novel referral, engagement and communication phone applications will generate first profits within two years, investors would be wise to monitor its developments closely at these prices. Nonetheless, Reffind could have a very exciting future ahead of it.
Buy, Hold or Sell?
Small-cap stocks offer superior returns to their blue chip counterparts in the S&P/ASX 200. However, volatility and greater risk is part-and-parcel with investments in the small-cap space. Of the above three companies, I think Bulletproof offers the best upside at today's prices (I recently increased my holding through a share purchase plan). Further, I recently took some profits from my Reffind holding off the table.
