How to Hunt Down Small-Cap Big Winners (Two Examples)

how to profit from small cap tech stocks

Welcome back to your Extreme Small-Cap Profits email course.

We’re now on Day 10 of 12.

If you missed yesterday’s email, we’re talking about the economy and how it might affect your small-cap returns.

We saw that as business boomed, it was great times for small-cap investors. However, when the economy slows down, it tends to have adverse effects on small-cap stocks.

Today we’re going to take everything you’ve learnt and put it all together. We’re going to go from A–Z on finding and buying potentially profitable small-caps.

OK, let’s put all that theory into practice.

Turn over as many rocks as possible

There’s no secret to starting out. You’ve got to grind and look at as many small-caps as possible.

I suggest you don’t go through a list of the ASX one by one, although you’re more than welcome, too.

Instead, it might be more efficient to have an idea in mind first.

Maybe you want to find small-caps that have been growing in sales over the past three years. You could find this by using a free screening tool.

There’s a bunch of them available. Yahoo offers easy to use stock screeners that can speed up your search time.

Alternatively, you might want to look for opportunities first. For example, if you believe the tech sector will continue to boom, you might want to look in that specific industry.

Maybe you think automation or data will be big business.

With that idea in mind, you can dig deeper and find small-cap gems ready to explode.

Again, it’s not really important how you come across small-cap opportunities, just as long as you do.

So read as much as you can, listen to investing podcasts and watch videos. Try to expose yourself to as many stocks as possible.

Legendary fund manager Peter Lynch saw hundreds of stocks each year. He would even hop on planes and fly around the world to find new companies.

Lynch figured he’d find one good stock for every 10 he looked at. Of course, that’s just a rough estimate. But it makes sense that the more small-caps you look at, the better chance you’ll have to find more 10-baggers.

By the end of his career, he turned millions into billions!

The advice Lynch gives to aspiring investors is the same I’m giving to you now. Turn over as many rocks as possible.

Now let’s take a look at two small-caps and run them through the gauntlet. 

Two potential gainers

The technology industry has been extremely active in the last decade. You always hear about a new tech start-up trying to disrupt an industry.

Whether it is fintech, blockchain or cyber security, technology is always striding ahead.

So how can you profit from new tech start-ups, innovation and a changing landscape? I’d argue investing in a small intellectual property (IP) business wouldn’t be a bad bet.

Such a business helps tech companies file patents and trademarks. They also help companies maintain those patents for years to come.

That’s why I think Xenith IP Group [ASX:XIP] could be an interesting idea.

The stock’s been listed for a little over two years. In 2017, Xenith bought two IP firms. They launched a separate specialist IP advisory firm. They also more than tripled the number of their IP professionals.

The company is profitable, sales are growing. From 2016–17, sales more than doubled from $35.8 million to $85 million.

Xenith has very little in debt and generated $8.5 million in free cash flow.

The stock has fallen recently because their short-term performance was below expectations. However, the company is benefiting from the strong Aussie patent and trademark industry.

Each year more than 28,000 patents and 71,000 trademark applications are made in Australia.

If Xenith can carve out a small portion of this market, earnings and their share price could go through the roof.

Of course, there’s no guarantee the stock will rocket up over the next few months. But clearly there’s potential for the stock to rise even higher.

You could say the same about Zip Co [ASX:Z1P].

This $322 million company allows merchants to sell more by offering delayed payment plans to consumers. You might have even seen zip money at some of your local retailers.

In their network of merchants is Kogan.com, Spotlight, Fantastic furniture, Webjet, and others.

The company grew sales from $2.9 million to $16.4 million in 2017.  The company is yet to turn a profit, but that could quickly change as the group continues to grow their customer base.

While the group has a huge loan to finance their service, it’s very manageable judging from what customers have already borrowed.

The group spent more than $7 million in cash last year, and have around $19 million in cash. That means the company could realistically, keep things going for more than two years before having to raise money.

Westpac has already shown their support for the small-cap by giving them a $40 million investment.

In the first month of 2018, Zip share price has almost doubled, climbing more than 73%.

Money Morning 26-04-18

Source: Google Finance

[Click to open new window]

Once the hard parts over

As you can see, the hard part is actually finding these stocks. Determining whether they’re worth an investment is not necessarily that hard.

You’re just looking for small companies that can grow earnings significantly.

That about does it for Day 10.

Now you should be able to find potentially profitable small-caps all by yourself. But maybe you’re still not convinced small-caps are for you?

That’s why tomorrow, in Day 11, I’m going to show you why you’ve got to invest in these tiny companies.

Until then.

Cheers,

Härje Ronngard,
Editor, Money Morning

Harje Ronngard

Harje Ronngard

Harje Ronngard is the lead Editor at Money Morning. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.

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