2 Risky Small-Cap Stocks to Play An (Eventual) Economic Recovery

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These two risky small-cap stocks could pay off big if they can weather the next few months of choppiness.

We have recently experienced the fastest market crash and fastest market “recovery” (at least a short-term one) in history. Why? Because of a global health crisis and forced recession, followed by unprecedented government stimulus to avoid systematic failures across the most crucial operating systems of our economy.

While the near-term path forward is uncertain, what’s crystal clear is that there is unlimited monetary and fiscal stimulus at the ready to fight the economic fallout from this pandemic. Broadly speaking, that’s good for stocks, though clearly there is a wide variance in the amount of risk individual stocks carry.

For investors thinking they don’t want to waste this correction by sitting idle, the question now is not so much if to buy stocks, but what stocks to buy.

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Below I’ve selected two risky small-cap stock options for the risk-tolerant investor that’s able to look past the next two to three months. These stocks have been beaten down because their revenues are tied to at-risk areas of the economy.

That said, investing isn’t about what will happen next week or next month, but over the next year or more. For the intrepid investor who can look past the immediate issues, these risky small-cap stocks represent compelling values right now.

2 Risky Small-Cap Stocks for the Eventual Recovery

Risky Small-Cap Stock #1: Cardlytics (CDLX)

Cardlytics is a $1 billion market cap company that has developed a purchase intelligence platform that is in the early innings of being adopted by financial institutions in North America and the U.K.

The platform pulls in and analyzes trillions of dollars of raw purchase data (debit, credit, ACH, bill pay, etc.) from millions of accounts at thousands of financial institutions. That data is then run through a machine learning technology which spits out a view of where and when consumers are spending their money. Advanced analytics are then applied to the anonymized purchase data to turn it into something of value that Cardlytics can sell to marketers.

These marketers, which include brands we’re all familiar with across the retail, restaurant, subscription service, travel, grocery, luxury and e-commerce channels, use the data to identify, reach and influence huge numbers of potential buyers with customized offers.

The distinguishing attribute of the platform, and major source of competitive advantage relative to other marketing platforms, is that Cardlytics reaches consumers directly through their online banking platforms and mobile banking apps. Cardlytics first landed Bank of America, then Chase and Wells Fargo. Most recently U.S. Bank became a customer. Some of these programs, like the one with Wells Fargo and U.S. Bank, are rolling out right now. In the U.K. both Lloyds and Santander have been live for over five years.

Banks win because they get reliable revenue – roughly 50% of revenue is shared with the banks – and have more active and engaged customers. Customers win because they save on everyday purchases that they would have made anyway and, other than clicking on the offer while logged in to their banking app or website, they don’t need to change their behavior. Marketers win by reaching engaged and receptive audiences, and they can measure the results of their efforts.

Can investors win with Cardlytics right now?

Last year Cardlytics’ revenue was up 40% and the stock was on fire, until the pandemic hit. There’s no doubt that consumer spending, which accounts for 70% of U.S. GDP, is falling in many categories. Marketing budgets have been scaled back as well. In the very near-term revenue will likely take a hit, thought we don’t know how much will be trimmed off the top and for how long. In short, while management hasn’t revised guidance just yet, consensus estimates for 28% revenue growth in 2020 carry a high degree of uncertainty.

That said, Cardlytics’ stock is 60% off its high. There’s a lot of bad news already priced in. That’s why this is a high-risk, high-reward stock right now.

The bottom line is we won’t know until management gives an update on the current business climate, which isn’t expected until early May. In the meantime, for investors looking for a stock to play a rebound Cardlytics remains beaten up, but with big upside potential.

Risky Small-Cap Stock #2: Paylocity (PCTY)

Paylocity is a $4.6 billion market cap company that specializes in cloud software solutions for payroll processing and human capital management (HCM). Its target market is medium-sized organizations who turn to the company to help carry out recurring tasks and make strategic decisions in areas of payroll, core human resources, workforce, talent and benefits management.

Clearly there is a lot of uncertainty in this market given the surging unemployment numbers. In the short-term that may lead to a spike in digital paper shuffling as employee statuses change. We also don’t exactly know how the Paycheck Protection Plan, which will forgive loans if all employees are kept on payroll for eight weeks, will impact employees that were already let go.

For its part, Paylocity generates 94% of revenue from recurring fees for monthly software subscriptions and payroll, timekeeping and HR-related services. Some portion of revenue is dependent on the number of employees and frequency of payroll processing.

Stepping back from the here and now and looking big picture, Paylocity has been a high-growth company because its mobile-first delivery model and cloud-based solutions are easy to set up and convenient to use.

Revenue was up 26% in 2018 and 24% in 2019, when adjusted EPS surged 142% to $1.38. Taking a cue from competitor Paychex’s (PAYX) recent quarterly report (delivered on March 25), it’s reasonable to assume a good hit to Paylocity’s business in the first half of 2020 then a partial recovery in the back half, though sustained shelter-in-place and social distancing initiatives would likely impact the second half of 2020 as well.

Finally, it’s worth mentioning that management is looking for a growth path through this crisis. Paylocity recently announced the acquisition of VidGrid, which provides peer-to-peer video learning courses. Tools like this that help employee collaboration and engagement are vital during the current shutdown, and should retain customers afterward as well.

In short, Paylocity is in an industry that doesn’t have a very bullish outlook in the near-term. That lack of interest is justified, but also spells opportunity if the economy can open back up this summer. Trading 44% off its high, there is a lot of bad news baked into this stock already.

Tyler Laundon

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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!

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