Over time, small-cap stocks far outperform their larger cousins. The two-decade period between 1999 and 2020 saw the Russell 2000 small-cap index more than triple in value compared to a 120% return by the S&P 500. Not even the tech-charged Nasdaq 100 came close to catching the performance of these small-cap stock picks. That’s why they need to be a part of your portfolio.
For shorter periods, small caps can lag. During the last one-, three-, and five-year time frames, the Russell 2000 was dead last in performance. But that just means the little guys are being offered at a bigger discount than their mid- and large-cap brethren.
Although the sector is going through a rough patch now, the following three small-cap stock picks offer incomparable value for November. For patient investors, these tiny acorns can grow into mighty oaks.
DigitalOcean (DOCN)
What better way to benefit from the long-term growth potential of small-cap stocks than to invest in a small-cap business catering to small- and medium-sized businesses (SMBs)? DigitalOcean (NASDAQ:DOCN) simplifies the move to cloud computing for startups and SMBs. It makes the cloud accessible for companies that haven’t attained the size to afford the services of Amazon (NASDAQ:AMZN) or Microsoft (NASDAQ:MSFT).
DigitalOcean says its platform lets a business go “from inquiry to deployment within minutes, without any specialized training or heavy implementation.” That’s perfect for companies who don’t have large IT departments or any IT department at all. They just want to get it done and have it work. Yet DigitalOcean’s services can grow as the customer scales up in size. More tools can be added to their toolkit as more services are needed.
Revenue is up 28% year to date, but expect that to grow significantly greater in the future. DigitalOcean recently acquired PaperSpace, an artificial intelligence (AI) cloud provider, that brought 500,000 customers with it. Coupled with DigitalOcean’s own 616,000 clients, the opportunity to offer enhanced services just multiplied exponentially.
Net dollar retention rate, or the amount of new money existing customers spend with it each year, was growing rapidly but shrunk from 112% last year to 104% this year. That’s due to SMBs feeling the pinch of high interest rates more acutely than larger companies do. They had to rein in spending, although they are still spending more. Even so, DigitalOcean’s stock is down 61% from recent highs.
However, at 12 times earnings estimates and 16 times free cash flow, DigitalOcean is attractively valued for long-term wealth generation.
Innovative Industrial Properties (IIPR)
Medical marijuana real estate investment trust (REIT) Innovative Industrial Properties (NYSE:IIPR) is the next unstoppable Russell 2000 stock to consider. Leasing facilities to marijuana growers is just as lucrative a business in the pot industry as it is in commercial real estate and elsewhere. Although interest rates are hitting marijuana stocks hard, too, the company has strong foundations that won’t be rattled by short-term events.
The REIT owns 108 properties across 19 states with approximately 8.9 million rentable square feet. What makes Innovative Industrial so stable is it operates under long-term, triple-net leases exceeding 15 years. That means tenants, not the REIT, pay the taxes, maintenance and insurance on the properties. IIP just manages its portfolio and enjoys a reliable, consistent stream of rental income. That reduces operational risks for investors.
In just-released third-quarter earnings, revenue grew 10% from last year to $77.8 million, resulting in a similar profit increase. Adjusted funds from operations (AFFO) were 7.5% higher. AFFO is similar to free cash flow for REITs.
Like all REITs, IIP is required to pay out most of its profits as dividends. The payout currently yields 10% annually. It has raised the dividend consistently since going public in 2016, growing it at a 42% annual rate. Yet the stock is taking it on the chin this year. Shares are down 28% in 2023. With the long-term trend for marijuana up, however, Innovative Industrial Properties stands to benefit from future legalization efforts.
Duolingo (DUOL)
Unlike the previous two small-cap stock picks, Duolingo (NASDAQ:DUOL) is doing quite well. Shares more than doubled in value over the first 10 months of 2023 despite pulling back 17% from recent highs. Who knew learning a new language could be so financially rewarding?
Duolingo language learning app is available on Apple’s (NASDAQ:AAPL) iOS and Alphabet’s (NASDAQ:GOOG, NASDAQ:GOOGL) Android platforms. It uses a freemium business model where users can access the app free for basic learning tools but must pay for more advanced educational applications. Although most users use the free service, Duolingo has 5.2 million paid subscribers globally, up 59% year over year. That’s 7.4% of its total 74.1 million monthly active users, giving it massive growth potential as it may be able to convert free users to paid through AI.
Earlier this year the language specialist launched Duolingo Max, which gives subscribers access to AI tools like Roleplay. Utilizing OpenAI’s ChatGPT-4, it creates an interactive tool to simulate conversations in other languages. That greatly enhances the value of the language app because a person learns best how to speak by actually conversing.
Now Duolingo’s stock isn’t the same bargain it was a year ago after its run-up. Yet the company only went public two years ago and began trading at $140.25 a share. That means the stock is available for only 13.6% more than what you could have bought it for back then.
Analysts expect the global language learning market to grow at a compound growth rate of 20% annually to $337.2 billion by 2032. Duolingo should capture a large share of that market opportunity.
On the date of publication, Rich Duprey did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.