One Small-Cap Stock that Could Be the Next Salesforce


How a Ski Trip Helped Reveal the Next

Two weeks ago I took a break from small-cap stock investing and brought my three-year old son on a ski trip to Vermont. The primary mission was quality time together. But a close second was to lay the foundation for a lifetime of skiing, without him feeling like learning to ski was a chore. 

The specific goal? Get him to the stage where he could turn, snowplow and stop on command. Doing so would mean he could move off the Magic Carpet ground lift, and start skiing the chairlifts without any restraints (ropes, Dad’s hands, etc.).

Working as a part-time ski instructor in my early 20s taught me an incredibly valuable lesson that served me well on the trip: develop an action plan and set parameters appropriate to the environment, and most kids will thrive on the ski hill. And provided there are aptly timed hot-chocolate breaks and fun on-snow games, a few days is usually all it takes to get kids going.

To make a long story short, we accomplished the goal. By the time we left the mountain on the last day, I was following him down the mountain as he led me around turns and through the paces of “red light, green light.”

The experience reminded me, again, how fine the balance between guide and governor is, both as a parent and as a ski instructor. One must move swiftly between the two, depending on the circumstances. Because once you leave the Magic Carpet and tell a three-year old to “show me what you’ve got,” the ski resort has the potential to morph into the arena from The Hunger Games. It can be absolutely terrifying.

But if you have that action plan, along with the basic skills to navigate the terrain and maintain respect for your environment, the resort stays true to its roots of being a place for both challenging and extremely rewarding experiences.

So what does this have to do with small-cap stock investing?

A lot, actually. On the drive home to Rhode Island, I spent a good deal of time thinking about the similarities between small-cap stock investing and teaching a toddler to ski. The two aren’t all that different; both are relatively young, small and volatile. But they deliver extremely rewarding returns, if you oversee them with the right mix of guide and governor.

Investing, and particularly small-cap stock investing, is all about developing a plan, positioning your portfolio to execute on that plan and continuously monitoring the investing environment. Certainly, adjustments have to be made along the way. But without a strategy and some basic skills to help execute, the stock market, like a ski hill, can turn ugly pretty quickly. It’s better to have an idea of how you’ll navigate the terrain ahead of time.

Small-Cap Stocks Now Lead in 2016

To illustrate the point, I thought I’d share a couple of forecasts I made in the 2016 Small Cap Forecast that I send to Cabot Small-Cap Confidential subscribers at the beginning of every year. The forecast isn’t meant to be a rigid framework. It’s more of a discussion of trends and humble predictions that can help guide specific stock picks in the year ahead. This is what I wrote in late January:

“Small caps will outperform large caps in 2016. After rising for five of the six years between 2009 and 2014, small caps (and large caps, for that matter) hit a wall of worry in late 2015, and slid down that wall in the first month of 2016. The first half of the year will continue to be scary, but not the beginning of a recession, in small caps or the U.S. economy. Given that small caps outperform over the long-term, yet have underperformed large caps for two consecutive years (2014 and 2015), and have fallen so much year-to-date, I see solid potential for small-cap outperformance over the next 12 months.”

When I wrote this on January 26, small caps were down 9% year-to-date and large caps were down 7%. Both would fall further in February. But as of the first day of trading in Q2 (last Friday), small caps were up 2.4% year-to-date and large caps were up 1.4%. That tailwind helped the February and March Cabot Small-Cap Confidential recommendations rise by 27% and 23%, respectively.

I also wrote:

“Cloud software stocks will outperform by a wide margin. The power of the Internet is a well-known theme, as is the power of the software-as-a-service business model. And for good reason, cloud software is relatively easy to buy, cost efficient, and offers a key benefit that’s become a necessity in the connected world: access from anywhere. It’s little wonder that IDC forecasts that cloud software will drive 50% of all software investment through 2019 (equal to average annual growth of 18.3%). With small-cap software stocks underperforming large caps for the first time in five years in 2015, valuations down as much as 30% from their 2015 highs, but many companies meeting expectations and growing revenues north of 25%, select names appear ripe for the picking. Small-cap names with revenue and earnings growth, healthy end markets and good management, should beat the market by a wide margin in the year ahead.”

Many cloud software stocks fell sharply with the broad market in early February, not long after I wrote that. However, they also rebounded quickly, and the stronger ones are still climbing today. For instance, (CRM) started 2016 around 77 then fell by 30% to 54 in early February. It has since rallied 40% to 76, just shy of where it began the year. I still think there is tremendous upside in this group, particularly in small-cap software stocks. That’s part of why I recommended another small-cap software stock last Friday.

Is this Small-Cap Stock the Next (CRM)?

A couple of weeks ago, I received the following email from a Cabot Small-Cap Confidential subscriber. He had a question about a software stock I recommended in the beginning of January.

Hi Tyler, 
I'm down 13.6% in ...; bought it on the way down not long after subscribing. 

It is my biggest loss among all my holdings. What do you see for the future?

For the record, my official stop loss policy in the advisory is 30%. I’ve found that’s about the right amount of rope to give small-cap stocks, given their tendency to bounce around a bit, especially when the broad market gets volatile (as it has been). And also for the record, we’re not going after 10%, 20% or 30% gains here.

We’re looking for 50%, 100% and 1,000%! So the rare 30% loser isn’t a big deal given the average gains small-cap stocks tend to deliver.

My response to this subscriber reflected not only my research on the January small-cap stock in question, but also the aforementioned forecasts that made in January. This is how I responded:

Hi G., I think ... has a pretty good thing going with its main products (..., etc.). And the supporting products are adding incremental revenue. All this business is reasonably stable, and gives the company the flexibility to try out new ventures (like ...) that could make a major impact. So I think the basic business model is intact and attractive.

My sense is that the stock’s recent performance (or lack thereof) has more to do with the broad market correction in general, and a re-rating on software stocks specifically. If we look at the charts for other relatively high-quality software stocks (CRM, SABR, TYL, MANH, etc.) there’s a fairly consistent pattern—they were going along fairly well until Q4 2015, then fell extremely hard right at the beginning of 2016, finally bottoming in early February. Now the question is which ones will claw their way back, and which ones won’t. I think  ... will be among the group that does.

Obviously I could be wrong, on either my sense of software stocks or ... specifically (or both). But this how I’m looking at things. And it’s also how I’m positioning for things as we head into Q2. I know none of this is extremely specific to  ..., but take it as an indication that I feel the company is doing about as expected—the stock just needs to work through this recovery process. 

I don’t pretend to know where this stock or the market will go tomorrow, the next day or the next quarter. But just as any parent who takes their kids skiing is probably assuming that they’ll stay on the trail, stock investors assume that the stocks they buy will go up. It’s all based on experience and (hopefully) realistic assumptions. Both suggest to me that this stock will be a good deal higher by the end of the year.

If you’d like to join me in my small-cap stock adventures, I’d love to share my research and perspectives with you. I’m always on the lookout for the next Salesforce (CRM), Microsoft (MSFT), Tesla (TSLA) or Facebook (FB) in Cabot Small-Cap Confidential.


Tyler Laundon
Chief Analyst of Cabot Small-Cap Confidential 2.0

Stock Picks


This stock could rise 50% before becoming fairly valued.

This hot technology company is growing like a weed, thanks to products that speed up cloud communications.

This stock is somewhat well known, but far from well loved.

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