Before a stock becomes a large company (and attains multi-bagger status along the way), it often starts out as a much smaller company.
This is why small-cap stocks can be interesting. Such companies may have the potential of earning you multiples of your initial capital if it is able to grow for an extended length of time.
When small is beautiful
The FTSE ST Small Cap Index could be a good place to start looking for small cap stocks. As of 30 November 2015, the index houses 89 constituents. The best performers for the index year-to-date (up till the end of November), are listed below:
- Riverstone Holdings Ltd (SGX: AP4)
- Q & M Dental Group (Singapore) Limited (SGX: QC7)
- Cordlife Group Ltd (SGX: P8A)
- Tiger Airways Holdings Limited (SGX: J7X)
- Interplex Holdings Ltd (SGX: M1P)
- iFast Corporation Ltd (SGX: AIY)
Riverstone Holdings, a glove manufacturer, has recorded a total return (inclusive of dividends) of 140.6% from the start of the year up till the end of November. This stupendous performance makes it the top dog in performance this year. Shares of Riverstone Holdings have also returned close to 500% over the past three years.
Q&M Dental Group and Cordlife Group are another two stocks which have provided solid returns so far this year. They have clocked in a total return of 75.3% and 73.6%, respectively.
Tiger Airways Holdings is one which may raise an eyebrow. The low-cost airline operator has recorded a handsome return of 54.7% this year. However, its shares are notably still down by a quarter over the last three years.
This raises the question: Will this year’s returns be indicative of future returns?
The poor three year returns for Tiger Airways may have left us a clue.
For one, the airline industry is a tough one to operate in. This could be why Tiger Airways has not been able to generate free cash flow from its fiscal year ended March 2009 (FY2009) to FY2014.
As such, we may want to question if Tiger Airways’ good stock returns this year can be supported by underlying business growth in the future. Singapore Airlines Ltd (SGX: C6L), Tiger Airways’ parent, is looking to take the low-cost carrier private, so the point about thinking of Tiger Airways’ future stock returns may be moot.
But, there’s a broader application to the thinking process we just went through – and that is, a stock’s return in any particular year may not be indicative of its future longer-term returns. How a stock eventually performs will be down to the performance of its business.
Small cap stocks can be a good place to start if you are looking for multi-bagging returns.
However, we have to move beyond the yearly performance of their stock prices to look at the long term potential of their underlying businesses. If we can do so, we may improve our chances of earning a satisfying long-term return.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.