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3 Small-Cap Stocks With Big-Cap Potential

Investing in small-cap stocks can be a fantastic strategy for growth investors -- if you can pick the ones that grow into large-cap stocks. A small-cap is defined as having a market capitalization between $300 million and $2 billion, while a large-cap is defined as having a market capitalization over $10 billion.

With that in mind, Axos Financial (NYSE: AX), Telaria (NYSE: TLRA), and Yext (NYSE: YEXT) are three diverse small-cap stocks that I believe have big-cap potential.

1. Axos Financial

Axos was formerly known as Bank of the Internet -- a nod to the company's branch-less banking business model. But the name change reflects an expanding focus. Rather than primarily servicing single-family mortgages as before, it now looks to provide a variety of banking services including auto loans, financial advice, and brokerage services.

New products and services promote a long-term growth narrative for Axos. But while these new revenue streams are currently just trickles, Axos is still experiencing solid growth in its business. The company reported record annual net income of $155 million in 2019, and record quarterly net income of $41.3 million in the second quarter of fiscal 2020. This is being driven in part by high growth in loans and leases activity (up 12.5% year over year in Q2).

AX data by YCharts.

Looking at the three-year chart, this stock is clearly underperforming the business fundamentals. That gives me reason to think it has short-term upside potential. But looking long term toward large-cap stock status, this isn't a flashy company that will get there overnight. That means investors will likely have to hold through a downturn in the economy at some point.

Yet Axos is well-positioned to endure tough times. A major portion of this business is mortgage lending, and Axos' average loan-to-value ratio for its entire real estate portfolio is 56%. This means that in a worst-case scenario, if the economy turned and people began to default on their mortgages, there is a substantial equity safety net for Axos to recoup its losses.

2. Telaria

The progressive death of cable television has led to many big-time stock winners, including streaming-champ Netflix, smart-TV operating system player Roku, and buy-side advertising company The Trade Desk. But that leaves out one very important part of the big picture: sell-side advertising. As eyeballs spend less time glued to traditional broadcasting, billions in ad money is looking for more effectiveness through connected TVs. The Trade Desk, on the buy side, works with ad agencies to get a cost-effective ad campaign. On the sell side, companies like Telaria work with connected TV (CTV) to maximize revenue. Connected TV is basically devices like smart TVs and TVs with internet connections through a game console, set-top box, or similar device.

Image source: Getty Images.

Telaria wants to become the sell-side company for CTV. And it's a smart move. According to eMarketer, 2019 CTV revenue was around $6.9 billion for the industry as a whole. For 2023, that number is expected to more than double to $14.1 billion. And at that point, CTV will still have plenty of growth opportunity, as only an estimated 5% of advertisers' budgets will be devoted to CTV.

Telaria's CTV segment revenue reflects this growth opportunity. It generated $7.3 million in the third quarter of 2019, up 115% year over year. But this stellar increase is overshadowed by declining revenue from non-CTV sources. Overall Q3 revenue was only up 23%. But Telaria is set to merge with The Rubicon Project (NYSE: RUBI), another sell-side company excelling in non-CTV revenue.

The two companies have provided preliminary combined results, giving investors a good picture of the future company. Full-year 2019 combined revenue is expected to be $224 million, representing 24% year-over-year growth. Interestingly, Rubicon's revenue will be up 25%, and it's mostly non-CTV revenue. Telaria's annual CTV revenue, on the other hand, is expected to be up 100%. This will give investors access to two complementary long-term growth engines.

3. Yext

When we go online looking for answers about companies (a menu, locations, etc.), we expect the information to be accurate. But that's not always the case, and it's challenging for companies to maintain correct information across the entire internet. Yext offers a solution to this problem.

The company went public in 2017 with just $89.7 million in trailing-12-month revenue, but an estimated total addressable market of $10 billion. While revenue has grown steadily, the revenue growth rate has consistently fallen. Slowing revenue growth coupled with earnings that are often below expectations has led to poor stock performance -- but that may be the market's shortsightedness.

YEXT data by YCharts.

By providing verified answers to search queries through search engines and virtual assistants, Yext has seen its current trailing-12-month revenue grow to $281 million. And growth in this area continues: The company just signed its largest enterprise customer ever with the Subway restaurant chain. But Yext has a new product called Answers that will provide answers to searches on a company's own website, rather than through other portals. Yext believes this one product doubles its total addressable market.

The company now estimates its total addressable market to be $20 billion. Consider that the stock currently trades at 6.5 sales. Capturing just 8% of that total addressable market at the current price-to-sales ratio would push its market capitalization over $10 billion. While Wall Street understandably wants to see better earnings, Yext seems to have that first-mover advantage in this growing market, and I love to see that when investing in small-cap stocks.

10 stocks we like better than Telaria, Inc.
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Jon Quast owns shares of Telaria, Inc. The Motley Fool owns shares of and recommends Axos Financial, Inc., Netflix, Roku, Telaria, Inc., and The Trade Desk. The Motley Fool recommends Yext, Inc. The Motley Fool has a disclosure policy.


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