It only takes a couple of very successful stocks to make a portfolio. In fact, you can have an abysmal portfolio, but if you pick two to three winners, it can lead to incredible overall returns.
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Small- and mid-cap stocks are the place for multi-baggers
Small- and mid-cap stocks are an excellent place to look for these winners. While small-cap companies can be riskier, the upside can be worth the risk. Small-cap companies can be just as strong as large caps. However, the market often underestimates or overlooks their potential.
Consequently, you can buy these stocks at a reasonable price while they are rapidly growing earnings/cash flows per share. You get the best of both worlds: earnings per share growth and earnings multiple expansion.
VitalHub: A small tech stock taking on a huge industry
VitalHub (TSX: VHI) is a great case study for this dynamic. It is a software provider to the healthcare industry around the world. In 2023, it traded for around $2.75 per share and had a market cap of around $110 million.
VitalHub was at an inflection point but not many folks on the Street were paying attention. VitalHub started to generate profits on a per share basis. Even more importantly, it started to consistently generate a lot of spare cash.
In June 2023, you could pick up its stock for 15 times free cash flow. Since then, the company has made several smart acquisitions and really scaled its platform. EBITDA (earnings before interest, tax, depreciation, and amortization) has risen 42.5% and free cash flow has risen 108%.
Today, it trades for 31 times free cash flow. Since June 2023, its stock has risen 310%. The great news is that VitalHub is still in the early innings of its growth journey.
The healthcare industry is incredibly inefficient. VitalHub has the software to help streamline processes, save money, and improve patient results. It also has the balance sheet to continue consolidating small software providers.
With a market cap of $558 million, the company could easily be 10 times larger one day. It is not cheap today, but opportunities will come to add this stock for the longer term.
Propel Holdings: A Canadian fintech success story
Propel Holdings (TSX: PRL) is another example of a small-cap stock that is now a mid-cap stock (in short order). Propel provides small loans to non-prime consumers through an online platform and bank partnerships in Canada, the U.S., and soon to be the U.K. (once it completes its acquisition of QuidMarket).
In May 2023, Propel traded for $7.32 per share. It only had a market cap of $235 million. At that time, it was largely focused on the U.S. market.
However, the company was delivering high returns on equity above 20% and earnings per share growth was steadily accelerating. At that time, the stock was yielding 5.5% and traded for only seven times forward earnings.
The company put up some great quarters where both margins and earnings per share significantly expanded. Its stock has risen 400% since.
Today, Propel trades for 22 times trailing earnings. Earnings per share is up 84% in the past 18 months. It has a market cap of $1.25 billion.
The company has a proprietary lending platform that can scale very quickly, at very little extra cost. As a result, earnings margins have rapidly risen, as have return on equity.
The company has new markets in Canada and the United Kingdom. Likewise, the U.S. remains a huge market that it can still grow into. This stock is volatile. However, if you hold on and Propel keeps executing, there is still substantial upside ahead.
