One of the key tenants of our investing strategy in Cabot Small-Cap Confidential is to buy small-cap stocks with sustainable business models. The reason is simple: We’re buying stock in companies relatively early in their life cycle and if they’re going to deliver big capital gains the business must grow every year for a long time. For that to happen the business model needs to create and deliver value for customers, while allowing the company to capture its fair share of that value in terms of revenue, earnings and cash flow. The same can be said of the best mid-cap stocks, which I’ll get into in a minute.
There are other factors that matter to a company’s long-term success, of course. Management, market demand, economic conditions, etc. all play a role.
But these important factors are usually encompassed in a good company’s business model, which should theoretically endure even if a founder steps aside, a recession hits, a key customer leaves or any other number of potentially disruptive events occur (and they’re bound to over the years).
With this in mind, let’s look at a few examples of mid-sized companies that have intriguing business models that could drive outperformance in 2019. Here are my three best mid-cap stocks for 2019:
We uncovered a cutting-edge company that could follow in the footsteps of our biggest small cap moneymaker of all time, Amazon, and turn another $10,000 into $129,000 or more. That’s a big claim, I know. But not when you understand how its revolutionary cloud-based emergency communications applications.
We uncovered a cutting-edge company that could follow in the footsteps of our biggest small cap moneymaker of all time, Amazon, and turn another $10,000 into $129,000 or more.
That’s a big claim, I know.
But not when you understand how its revolutionary cloud-based emergency communications applications.Click here for more details.
Best Mid-Cap Stock #1: Roku (ROKU)
Roku has a market cap of $7.8 billion and is a play on the streaming TV phenomenon. Its business model revolves around a delivery platform and sales of over-the-top streaming (OTT) players. This is different from other players in the market, such as Netflix (NFLX), that are pure content plays, as well as the Amazon (AMZN), Alphabet (GOOG) and Apple (AAPL) type of model that offers some combination of streaming, content and hardware as part of a much larger business.
Roku’s Platform segment generates revenue from advertising, subscription and transaction fees, sales of branded channel buttons on remote controls, and licenses from operating systems installed on TVs. Its Player segment includes sales of OTT streaming players. For the model to work Roku needs to keep pulling users in through low-margin OTT players (22% gross profit) and selling them high-margin advertising through the platform segment (70% gross margins). Platform revenue made up 46% of total sales in the last quarter, while Player revenue made up the remaining 54%. The business model has been working well and investors appear to think it will continue to do so in 2019.
Best Mid-Cap Stock #2: Viper Energy (VNOM)
Viper is another company with a compelling business model. It is an oil royalty company that’s organized as a variable distribution MLP. This is a business structure that’s been around for a while in the gold and silver mining market, but which is still somewhat new to the oil industry. Viper generates revenue by owning mineral rights to oil wells operated by other companies. It passes 100% of available cash flow on to unit holders. This is where the variable part of the business model comes into play. As revenue goes up, investors generate more income. As revenue falls, they get paid less.
Viper gives investors exposure to something they can’t easily get elsewhere—mineral rights. If you’ve ever dreamed of striking oil on your own property and cashing in on royalty payments for the rest of your life, Viper may be your best shot! Because it’s not an operator of other wells, Viper carries no company-specific operational risk or CapEx exposure. It simply pays its share of production costs and taxes to the operators, then passes 100% of available cash flow to investors in the form of variable dividend payments.
As with all oil companies, real estate matters. And Viper has some of the best out there. All assets are in the Permian Basin and Eagle Ford, and around one-third are owned by Viper’s parent company, Diamondback Energy (FANG). Business has been good. Revenue was up 117% (to $172 million) last year and EPS grew by 143% (to $1.07). Analysts see 75% revenue growth and 118% EPS growth this year, and the stock yields over 5.5%. Viper has a market cap of $8.3 billion.
Best Mid-Cap Stock #3: Inogen (INGN)
Inogen (INGN) is a $5.4 billion market cap company that makes portable oxygen concentrators for patients with chronic respiratory conditions. The product pitch is straightforward; patients can either tow around a cart with a huge oxygen tank, stay at home, or use one of Inogen’s Portable Oxygen Concentrators (POCs), which are about the size of a medium-sized handbag. Many are choosing to go with Inogen’s POCs, and it now owns almost half of the market because it has the best products out there.
Inogen sells business-to-business (B2B), but also direct-to-consumer (DTC). It recently completed a study that showed another price drop in the DTC channel could increase sales, so the new base selling price has recently gone down $200, to around $2295. These types of pricing strategies are driving rapid growth in the U.S. DTC channel, which was up 74% (to $38.3 million) in Q2. All in, revenue in Q2 was up 52% to $97.2 million. For 2018, analysts see 40% revenue growth and 60% EPS growth. It’s a great growth story and the business is likely to continue to do well in 2019.
An Unknown Small-Cap Stock
Now that I’ve unveiled my three best mid-cap stocks for 2019, I should also mention that I just added a small-cap stock to Cabot Small-Cap Confidential that has a business model I hadn’t come across before, but which looks extremely compelling.
I can’t say which industry it’s in, but the business model offers three differentiating elements that should help this small business deliver its services on a national scale.
The three keys to the platform are (1) separation of sales and service functions; (2) extensive use of cloud-based technology; and (3) a hybrid sales model deployed through both a corporate and franchise model.
The most interesting thing about this company is that while its industry is growing at 3% to 5% a year, it is growing north of 30% a year. And growth could easily accelerate to over 40% in 2019.
To learn more about this company and get my full report, you’ll need to subscription to Cabot Small-Cap Confidential. You can get that right here.
Tyler Laundon is chief analyst of Cabot Small-Cap Confidential. The circulation of Small-Cap Confidential is strictly limited because the undiscovered stocks with sky-high-potential that Tyler recommends are often low-priced and thinly traded. Don’t share these recommendations!Learn More