Investors often overlook small-cap stocks in favor of household names, but these smaller companies can offer compelling opportunities for patient investors. While these investments typically experience more price volatility than their larger counterparts, the potential for substantial returns makes them worthy of consideration.
Small-cap companies often operate in emerging markets where they can rapidly expand their market share. This stellar growth potential, combined with their smaller market capitalizations, can lead to significant stock price appreciation over time.
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Here are three small-cap stocks that have the pieces in place to deliver results better than the benchmark S&P 500 over the next five years.
Clean consumer products pioneer
The Honest Company (HNST -1.70%) focuses on clean and sustainable personal care products. The company recently reported solid second-quarter 2024 results, with revenue growing 10% to $93 million and gross margins expanding significantly from 27.1% to 38.3% year over year.
The Honest Company's operational improvements are delivering tangible results, marked by three consecutive quarters of positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). This sustained progress has enabled management to raise its full-year guidance for both revenue and profitability.
These improvements have caught investors' attention, with the stock price rising more than 222% over the past 12 months. While the company's turnaround efforts remain ongoing, its current market cap of approximately $378 million appears conservative given its established position in the multi-billion-dollar clean consumer products market.
Photonics innovation leader
Poet Technologies (POET -8.30%) develops photonic solutions for data communications and sensing applications, focusing on artificial intelligence (AI) and advanced connectivity needs. The company's stock has risen by a whopping 314% this year as it secures strategic partnerships and design wins.
The company recently announced a collaboration with Mitsubishi Electric to develop 3.2T optical engines for AI networks. Additionally, Poet Technologies has secured major design wins with Foxconn Interconnect Technology and Luxshare Tech for its high-speed optical engines, positioning the company to serve the expanding AI infrastructure market.
Despite these advances, Poet Technologies remains in the early commercialization stages with limited revenue. The company faces intense competition from established players in the optical components market and requires significant capital to scale its operations.
High-performance computing innovator
Applied Digital (APLD -8.80%) builds and operates next-generation digital infrastructure, with a focus on high-performance computing and AI applications. The company's first-quarter fiscal 2025 results demonstrated strong growth, with revenues reaching $60.7 million, up 67% from the previous year.
The Applied Digital strategy recently gained significant validation through a $160 million private placement, which included strategic investment from Nvidia. The company is expanding its cloud services while developing new facilities, including a 100-megawatt data center purpose-built for AI applications.
However, the company faces substantial execution risks as it scales operations and requires significant capital investment to build out its planned infrastructure. Competition in the high-performance computing space continues to intensify, particularly in the AI-focused segment.
Building wealth through small-caps
Small-cap stocks can provide significant growth opportunities for long-term investors. While these companies may offer higher potential returns than their larger counterparts and the broader market represented by the S&P 500, they typically come with greater price volatility and business execution risks.
These three companies, despite their promising market positions and recent strong performance, warrant careful position sizing within a well-diversified portfolio. Their early stage nature and ongoing capital needs make them more suitable for investors who can tolerate higher risk levels and maintain a long-term perspective.
