Editor’s Note: Today’s Wealthy Retirement comes from Research Director Kristin Orman, who plays an integral role in developing and refining the strategies behind our Oxford Club services.
Below, she pulls back the curtain on how she identifies the little-known stocks with the best chance to become household names.
Kristin contributes to our sister e-letter, Liberty Through Wealth, every week. For more insights from her and Chief Investment Strategist Alexander Green, visit the Liberty Through Wealth website.
– James Ogletree, Senior Managing Editor
Most investors think a cheap stock is one with a low share price.
It isn’t.
That’s because a $5 stock can be wildly expensive.
And a $100 stock can be dirt cheap.
When it comes to valuation, the price you pay for one share of stock matters very little.
What does matter is what you are paying for the entire business.
Let me explain…
Putting on the Market Cap
The value that Wall Street places on an entire company is called market capitalization or “market cap” for short.
Here’s how you get there… multiply the stock price by the number of shares outstanding. That’s it.
It sounds basic, but a company’s market cap can tell you a lot about the stock’s potential.
And there’s one number that serves as the “make it or break it” threshold for a lot of companies – $1 billion.
Here’s why…
Why Size Matters
Let’s say you’re considering investing in two companies.
Company A is worth $4 trillion.
Company B is worth $250 million.
For Company A to double, investors need to add another $4 trillion to its market cap.
That’s trillion with a T.
For Company B to double, it needs to add just $250 million.
Now, that doesn’t mean Company B will double.
Statistically, most tiny companies will never become large companies.
Worse, some will fail completely.
But the math shows why small stocks can produce returns that are almost impossible for the biggest companies in the world to match.
A $250 million business that eventually grows into a $1 billion company has increased fourfold in value.
If it reaches $2 billion, you’re talking about eight times the original market cap.
That kind of move can happen without the company ever becoming a household name.
And that’s what makes investing in small caps so compelling.
The Journey to $1 Billion
The $1 billion mark isn’t some magical number that I just made up.
A company doesn’t suddenly become better the moment its market cap crosses it.
But something often changes as a business gets larger.
It starts attracting attention.
More analysts may begin covering it.
More institutional investors can buy it.
Trading volume often increases.
The company may become eligible for indexes or investment screens that previously ignored it.
And all of that can bring new buyers into the stock.
Here’s where it gets really interesting.
You don’t necessarily want to wait until everyone notices the company.
You want to find it while the business is still small… but the numbers are starting to tell you it may not stay small.
There are thousands of tiny public companies.
Most of them are small for a reason, but the goal isn’t to buy small stocks.
The goal is to find growing businesses while they are still small stocks.
How It Works
Here’s my process. Suppose I find a company that is worth $300 million today.
The first question I ask isn’t, “Can this stock go to $1 billion?”
It’s, “What would it take to make this business worth $1 billion?”
There has to be a reason, such as accelerating sales, a new product, or a new major customer.
Maybe the company’s industry is expanding quickly, its profit margins are starting to improve, and/or its earnings estimates are moving higher.
Often, the best opportunities have several of these things happening at once.
That’s when a small business can enter a very different stage of its life.
Revenue grows.
Profits follow.
More investors notice.
Only then does Wall Street begin valuing the company based on where it is heading rather than where it has been.
And that’s when the stock can start moving higher very quickly.
Wall Street Can Afford to Be Late
There’s another advantage to looking below the $1 billion line.
Wall Street simply spends less time there.
It all comes down to economics.
A large investment bank can make plenty of money covering Apple, Nvidia or Microsoft.
Its institutional clients own those stocks, they trade them constantly, and everyone wants research on them.
A $200 million company is a different story.
Most large funds can’t buy enough shares of a $200 million company to make a position worthwhile.
Others avoid thinly traded stocks altogether.
So, as a result, smaller companies typically receive very little analyst attention.
That doesn’t mean the market knows nothing about them.
But it does mean fewer people may be digging through the filings, listening to conference calls, and watching for changes in the business.
That creates opportunity for investors willing to do a little work.
Small Isn’t Enough
There is an important warning here, though.
A tiny market cap by itself is never a reason to buy a stock.
In fact, I’d argue the opposite.
The smaller the company, the more selective you should be.
Small companies can have weak balance sheets, they can depend on one customer, and their shares can be volatile. And if the business runs into trouble, there may not be many buyers waiting underneath the stock.
That’s why we want more than a good story.
We want evidence.
We want to see growth.
We want catalysts.
We want a real reason that earnings could move higher.
And ideally, we want to see signs that the market is beginning to recognize what is changing.
The combination matters.
Small company + strong business momentum + a real catalyst is a very different formula from simply buying a cheap-looking stock.
The Opportunity Before the Crowd Arrives
Some of the biggest winners in the stock market began as companies almost nobody was talking about.
That’s easy to forget after they become famous.
By then, the story seems obvious.
But it rarely looked obvious at the beginning.
Early investors had to make a judgment while there were still questions.
They had to look at what the company could become rather than what it already was.
That’s the appeal of the $1 billion line.
It gives you a place to hunt for businesses that are still small enough for a major change in their fortunes to produce an outsized change in their stock price.
That’s the framework I use before I ever look at a specific stock.
The point isn’t to buy small companies just because they’re small – most of them won’t make it, and you should go in expecting that. It’s to find the rare businesses where a modest change in sales, earnings, or investor attention can produce an outsized change in the stock, and to be selective enough that the ones that don’t work out don’t sink you.
That kind of opportunity is much harder to find in companies that are already worth hundreds of billions of dollars.
And that’s why some of the market’s most profitable opportunities can still be found well before Wall Street starts paying attention.