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Three Underrated Small-Cap Stocks Expected to Surpass S&P 500 Growth in Five Years

Three Small-Cap Stocks Set to Outperform the S&P 500 Over the Next Five Years

While large-cap stocks often dominate financial news and investor portfolios, small-cap stocks can provide compelling investment opportunities for those willing to venture into the lesser-known territory of emerging companies. The last few years have shown that smaller companies can offer substantial growth potential, particularly as they operate in fast-growing markets. Despite typically exhibiting greater price volatility than their larger counterparts, their potential for significant returns makes them attractive for patient investors looking to enhance their portfolios. This article will highlight three small-cap stocks that appear poised to outperform the S&P 500 over the next five years.

The Honest Company (NASDAQ: HNST)

Leading the pack is The Honest Company, a pioneer in clean consumer products that emphasizes sustainability in personal care items. This past quarter, the company achieved impressive results, with revenues increasing 10% year-over-year to reach $93 million and gross margins expanding significantly from 27.1% to 38.3%. These operational improvements have resulted in three straight quarters of positive adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA).

Such sustained success has prompted management to upgrade their full-year revenue and profit forecasts. Investors have responded positively, with the stock surging over 222% in the last 12 months. Given its current market capitalization of approximately $378 million, many believe that The Honest Company’s valuation is conservative, particularly considering the multi-billion-dollar potential market for clean consumer products.

Poet Technologies (NASDAQ: POET)

The second stock highlighting this trend is Poet Technologies, which specializes in photonic solutions tailored for data communications and sensing applications. By focusing on artificial intelligence (AI) and high-speed connectivity, the company has seen a staggering 314% increase in stock price in 2023. This remarkable growth stems from securing key strategic partnerships and design wins, including a collaboration with Mitsubishi Electric to develop 3.2T optical engines geared toward AI networks.

Furthermore, Poet Technologies has achieved significant design wins with Foxconn Interconnect Technology and Luxshare Tech for its high-speed optical engines, which positions the company well within the expanding AI infrastructure market. However, it is essential to note that Poet Technologies is still in its early commercialization phases, grappling with fierce competition from established industry players. The company requires substantial capital to effectively scale its operations, making this investment more suitable for those with a higher risk tolerance.

Applied Digital (NASDAQ: APLD)

Lastly, Applied Digital is gaining traction in the realm of high-performance computing, with a primary focus on AI applications. The company’s fiscal Q1 results showcased strong growth, reflected in revenues of $60.7 million—a 67% increase compared to the prior year. Their strategy recently gained serious credibility through a $160 million private placement that included substantial investment from Nvidia.

Applied Digital is working to expand its cloud services alongside constructing new facilities, including a 100-megawatt data center specifically designed for AI applications. However, with great opportunity comes significant execution risks as the company scales its operations, requiring hefty capital investments. Furthermore, competition in the high-performance computing sector, particularly focused on AI, continues to intensify, necessitating vigilance for investors.

Final Thoughts: Building Wealth Through Small-Caps

Investing in small-cap stocks can provide significant growth opportunities for those with a long-term perspective. While these companies present higher potential returns than larger entities and the broader S&P 500, they typically come with an increased degree of price volatility and execution risks. The Honest Company, Poet Technologies, and Applied Digital each demonstrate strong market positions and recent robust performances, making them worthy of consideration.

However, investors should approach small-cap stocks with caution, ensuring careful position sizing within a diversified portfolio. Notably, the early-stage nature of these companies combined with their ongoing capital needs makes them best suited for those investors willing to shoulder higher risks in exchange for the potential of greater rewards over time.