Have you ever seen those Russian matryoshka dolls? You might even own a set. I remember, as a kid, my mum and dad had a set. Don’t know if they were ‘authentic’ ones or not. But I do remember they were fun.
They’re the ‘doll in a doll in a doll’ wooden ornaments that are popular the world over. You know the ones — when you open the big one to reveal a small one inside. Then you open the smaller one to find an even smaller one inside. Then you open…well, you get the point.
Matryoshka dolls are often a good metaphor for how something can have multiple layers and added value inside.
But when it comes to stocks, and in particular small-cap stocks, I like to think of the ‘reverse matryoshka’. Now, that might sound like a difficult figure-skating manoeuvre, but it’s not.
It’s the idea that something small can become something bigger and bigger and bigger, without drastically changing appearance or purpose.
Think about it like this…
The reverse matryoshka in operation
You’re a small company, maybe only worth $80–$100 million. To most people, that’s a big company. But on a stock exchange, that’s a small-cap. When you compare it to the likes of Commonwealth Bank [ASX:CBA] or Telstra [ASX:TLS] ($122 billion and $61 billion respectively), $100 million is small.
At $100 million, you sign a big deal with an overseas company. This deal gives your company, and your products, access to 1.3 billion people in China. A few months later, off the back of good news and growing revenues, your company is now worth $220 million.
That’s over 100% growth in size.
But then you go even further and realise that growth in China is far better than anticipated. In fact, your revenues and margins are growing at a rate you didn’t even expect. You inform the market. A week later, your company is worth $330 million.
That’s a 50% jump from $220 million. But it’s an incredible 230% higher than the initial $100 million.
This continues. And, incrementally, the company grows. Maybe not as much as the initial 100% growth, but 10% here, 20% there… Before you know it the company is worth $1 billion.
Once worth $100 million, it’s now valued at $1 billion.
This isn’t just some made up fictional story. This happens to real companies. Real small-cap companies that go from being worth tens of millions, to billions.
Resolute Mining [ASX:RSG] is now worth $1.38 billion, with a stock price of $2.10. A year ago they were trading at 27.5 cents.
Then there’s Audio Pixels Holdings [ASX:AKP]. In February this year, you could have bought AKP stock at $7.00 per share. By late July, each share was worth $33. Just an easy 371% gain.
I might point out that now, even with their share price at $24.78, Audio Pixels is still worth around $666 million.
Investors that get into these stocks early, before the big gains come off the table, can make the kinds of profits that you simply can’t get with other, larger kinds of stocks.
Can you see a company like Telstra growing quickly from $61 billion to $122 billion? That would make them the biggest company in Australia. And could you see them going from $122 billion to $183 billion?
That would make them almost as big as International Business Machines [NYSE:IBM].
It’s just clearly not going to happen. Not in your lifetime, anyway.
Where to invest in ‘The Age of Extreme’
Large-cap companies, or ‘blue chip’ stocks, simply don’t have the potential to provide investors with monumental gains on the market. I believe that the only place you can invest in great companies with immense opportunities is in the small-cap section of the ASX.
Now, I will also say that these stocks do come with a high degree of risk, too. So if your sole purpose in investing is to protect your capital for retirement, then small-caps probably aren’t for you.
But if you’ve got some ‘punt money’, or are prepared to take on risk, you’re in for a treat.
Today’s the day I launch a new report that’s all about the best kind of small-cap stocks on the ASX. These stocks I have a special name for, but you’ll have to read my report to find out what that is.
They also have the potential to perform in the absolute extremes of the market. In fact, right now, markets all over the world operate at extremes. One day, things are looking great. Markets setting new highs make for happy investors. The next day, a crisis is imminent, markets are crashing, and the world is over.
The special kind of stocks I look for aim to perform during both extremes. They can do well in great markets; and they can do well in a crisis. Now, I’m not saying these stocks always go up. That just doesn’t happen to any stock, ever.
These stocks see fluctuations like any other. But it’s when things are really bad, or really great, that they have the potential to do extraordinary things. The ability to operate in market extremes — in The Age of Extreme — is a feature I look for in small-cap stocks.
In today’s report, which you can read about here, I even identify four small-cap stocks I think will be the ones to own in 2017. They display the extreme abilities I look for.
This report has been a long time coming. It’s been a work in progress for over a year now. But it’s time to let it loose. With markets so uncertain, at such extremes, now is the time to figure out how you can make money.
Editor, Money Morning