Surfing Small Caps Provides a Wild—Yet Fulfilling—Ride
Searching for the Next Wave of Small-Cap Profits
Time to Consider GoPro (GPRO)?
As I sat in the ocean last Monday, watching the rising sun and waiting for Hurricane Joaquin to serve up the next set of overhead waves, I pondered the many similarities between surfing and small cap investing.
Both activities come with a lot of downtime. My wife often asks how many waves I’ve caught after having been gone from 5:30 am to 7:30 am. And the typical answer of “a few good ones” could be interpreted as not that many at all.
But with surfing, as with investing, it’s more about quality than quantity. A good wave or two can lift you up for days. And a good small-cap stock can lift you up for far longer than that.
Both activities begin with a single, decisive moment in time. That moment where you try to peer into what could be, and either go for it, or don’t. That split-second decision defines more than just the next few moments—it showcases your ability to factor in past experience, what you see right in front of you (and just beyond), and your sense of all the intangibles that culminate in a gut feeling of right or wrong.
There are notable differences, too. Because while both surfing and investing begin with the same goal—jump on-board for a nice ride—surfing is far more fleeting. No matter how perfect the wave, it won’t last very long. Most rides are measured in seconds, and the beach always marks the endpoint.
There is no such well-defined endpoint when small-cap investing. You can ride that baby for weeks, months or years. Heck, it can even be ridden for generations if the stock is good enough!
And that’s the ultimate goal when seeking out the next great small cap; a stock that you can tuck away and let cumulative gains work their magic.
I’m sure you can find similarities between investing and whatever recreational pursuits get your blood pumping. This is just one that I’ve thought about many times while waiting for the next wave, and the next small cap, to pop up in front of me.
Speaking of popping, stocks have done just that over the past week. Finally.
There was a lot of anxiety in August and September. And the market uncertainty manifested into a pretty steep decline across global markets. My favorite asset class, small caps, was far from immune to the weakness.
But like waves on the ocean, the market moves in cycles over time, and long-term performance is improved by buying in troughs, not at crests. That’s why I recently increased the size of a few long-term positions in my personal small-cap portfolio, and advised Cabot Small-Cap Confidential subscribers to do the same.
I think it’s worth pointing out that even though there are a lot of negative market influences around the globe, we are emerging from what is typically a weak period of the year. And maybe that, more than anything else, is what investors should consider right now.
To drive the point home, I calculated large-cap and small-cap returns from the first of August through the first of October for each of the last three years. Do you know what the average return was? For large caps, it was negative 2.8%. And for small caps, negative 2.9%. The returns for each year are displayed in the graph below.
I think this is pretty interesting. Especially considering that full-year returns (I’m using YTD returns for 2015) have more than made up for the fall weakness. The average annual return since 2013 has been 13% for large caps, and 14.4% for small caps. This is what those annual returns look like, and if you do a few quick calculations, you’ll realize that the majority of the market’s annual performance comes outside of the August to October stretch, or at least it has since the beginning of 2013.
The message here is that, if you subscribe to the notion that stock market returns come in waves, as the evidence suggests, it looks like now is a pretty good time to jump on a small-cap stock or two.
The chart of the S&P 600 Small Cap ETF (IJR) has just broken above its 50-day moving average for the first time since mid-July. And given the recent decline, there are a lot of small-cap stocks out there that appear to offer compelling entry points.
One of these is a small-cap stock that attracts an equal amount of lovers and haters, whether in the market, in the water, on the snow, or anywhere else there is action to be found.
The stock is GoPRO (GPRO), which hit a post-IPO low last week after falling more than 50% from its August high.
I’m not a dedicated GoPro advocate, and I haven’t yet coughed up the cash for one of their cameras. But I find the stock compelling, despite that fact that I’m not fully convinced the company will fend off all the competitive threats out there, be able to innovate quickly enough to continue to grow its user base, or scale its media business.
I like GoPro for what it is now: a highly specialized device manufacturer that absolutely dominates in its niche product category. And I think that off that base, there’s a lot of future growth potential.
GoPro’s best days don’t seem behind it, and the brand seems as powerful as ever. It is showing up in bigger and bigger markets, getting called up from extreme sports to the big leagues, and making cameos on Hollywood movie sets. It is also expanding content distribution through partners that include Hulu and Comcast (CMCSA).
But what catches my attention most is the company’s pace of growth. Annual revenue growth in 2013 and 2014 was 87% and 41%, respectively. EPS growth was 115% and 138%, respectively, and gross profit margin expanded from 37% to 45%.
GoPro is on pace to grow revenue by 38% this year, to nearly $2 billion, and to grow EPS by 32% to $1.74. That is, of course, if consensus estimates are accurate, which they have not been. Over the past four quarters, the company has beaten estimates by an average of 40%, suggesting that even though the stock pops or drops on analyst rating changes, such ratings may not be worth paying much attention to.
The valuation of the stock seems to suggest a pretty sizeable disconnect with the company’s bottom-line results too. At the current price of just over 29, shares of GoPro trade with a forward PE of just 14, and a PEG ratio of 0.5. The price-to-sales ratio is a meager 2.2.
I look at those numbers and think that even if competition does increase, even if the company’s new small form-factor Session camera—its smallest and lightest yet—is a flop, and even if most people don’t want a GoPro stuck to their head, the stock is still attractive.
With the company making progress shrinking the form factor and introducing its own drone next year, I think there’s ample room for sales growth. And that doesn’t include what it could do if they can figure out how to make the cameras attractive to all the parents (like me) and grandparents who just want to capture everyday moments.
I don’t know if GoPro will go up from here. If it does, I don’t know if the ride will last weeks, months, years or generations. But I think it’s worth taking that first step and buying a little. Just like the action in front of the camera’s lens, the stock tends toward the extreme, and this selloff looks overdone. Earnings will be announced on October 28, and there should be a good deal of interest in the stock up to and through that event.
I’m always watching and waiting for that next wave of opportunity to appear in small-cap stocks. And I recommend my best ideas to Cabot Small-Cap Confidential subscribers every month. These readers are enjoying a pretty nice ride on my latest selection, which is up 15% since we jumped onboard October 2. With a little luck, the ride will continue.
If you’d like to join them and be first in line to read my next small-cap opportunity, I’d love you have you. You can get started right here.
Your guide to undiscovered small-cap stocks,
Chief Analyst, Cabot Small-Cap Confidential