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Investors want to see a return on investment, it’s as simple as that. Regardless of the size of the investment, the end goal remains the same. Sure, there are several ways to go about achieving this objective, yet some Wall Street observers believe that the highest upside potential – and the best place to look for the big returns on investment – is found in the small-cap category.
These are stocks valued at less than $2 billion in total market cap, and they typically (but not always) come along with low share prices.
The high upside potential is a direct result of the lower share price. For these stocks, even a small absolute gain in share value can translate into a large gain percentage-wise. The math gives these small-cap stocks a return potential that the headline-grabbing market giants can’t match – but it comes with an obverse, in the form of higher risk. After all, if small gains can turn to large returns, the same numbers will also magnify small losses. These are not investments for the faint-hearted.
For investors willing to take on the risk, however, the low-cost, small-cap equities can be the right choice to goose the upside of a stock portfolio. We’ve used the TipRanks platform to look up the details on three tickers whose shares meet the profile – low cost of entry, Strong Buy consensus rating, and a high upside potential. Let's take a closer look.
Decibel Therapeutics (DBTX)
We’ll start with a biotech company, Decibel Therapeutics. This clinical-stage researcher is solidly in the small-cap segment, with a market cap of just $189 million. The company is focused on the discovery and development of new treatments for unmet medical needs of the inner ear, to create ‘transformative’ treatments that will improve hearing and balance. Decibel has a proprietary platform to create precision gene therapies, based on single-cell genomics and bioinformatics analyses, to specifically target the hair cells of the inner ear.
These hair cells respond to movements and pressure changes in the fluid-filled canals of the inner ear, and we perceive those responses as changes in sound and physical orientation. Various conditions will affect the ear and its functions, including both genetic and medication-induced conditions. Decibel has tracks to attack both sources of ear function loss.
The company’s pipeline is mainly in pre-clinical stages, but one drug candidate, DB-020, is currently undergoing a Phase 1b human clinical trial. DB-020 is designed as a preventative treatment for hearing loss caused by cisplatin. Cisplatin is a common chemotherapy medication, but ototoxicity is a frequently reported adverse effect, and can lead to permanent hearing loss. The company is on track to release interim results from this proof-of-concept study in 1H22. DB-020 targets the inner ear through local delivery, and so may be usable to protect hearing without diluting the therapeutics effects of cisplatin.
Among the pre-clinical programs, DB-OTO is the standout. This gene therapy product was developed as a treatment for the profound congenital hearing loss caused by mutation of the OTOF protein. This mutation disrupts the signaling between the ear and the brain; the inner ear structures that perceive sound are fully developed. DB-OTO is designed to cause expression of functional OTOF protein in the inner ear hair cells, to allow transmission of sound to the brain.
The company expects to achieve several key milestones with DB-OTO in 2022, including submission of the Investigational New Drug Application (IND) to the FDA, and initiation of a Phase 1/2 clinical trial for pediatric patients. In an important step toward those milestones, Decibel announced in September of this year that the FDA had granted Orphan Drug designation and Rare Pediatric Disease designation to DB-OTO.
Covering Decibel Therapeutics for Baird, analyst Jack Allen sees these two programs as the keys, writing: “Decibel's diverse otology pipeline provides a number of ways to win. Starting with DB-OTO, the lead gene therapy, here we are encouraged by the preclinical data and believe that congenital OTOF deficiency is an indication well suited for gene therapy. Shifting gears to DB-020, Decibel's otoprotective therapy, we view this program as fairly der-isked... With clinical readouts expected over the course of the next 12-18months, we believe positive data from either one of these programs could result in significant appreciation of shares.”
Taking all of this into consideration, Allen rates DBTX an Outperform (i.e. Buy) along with a $21 price target. Should this target be met, a twelve-month gain of ~173% could be in store. (To watch Allen’s track record, click here)
Does the rest of the Street think DBTX can outperform in the long run? As it turns out, other analysts say yes. 3 “buys” compared to no “holds” or “sells” assigned in the last three months add up to a “strong buy” consensus rating. At $18, the average price target puts the upside potential at ~134%. (See DBTX stock analysis on TipRanks)
Landos Biopharma (LABP)
The second small-cap stock we're looking at is another clinical-stage firm in the biopharmaceutical industry. Landos Biopharma focuses on autoimmune diseases, an important category of illness that frequently carries a large number of unmet medical needs. Autoimmune diseases are serious conditions, in which the immune system attacks its own body.
Landos’s leading drug candidate is omilancor, a new treatment for ulcerative colitis and Crohn’s disease, both painful conditions of the intestinal system. Omilancor is a small molecule designed to target the Lanthionine Synthetase C-Like 2 (LANCL2) pathway. The action is intended to limit the gastrointestinal impact of the drug, and important consideration as patients with these GI disorders frequently suffer from considerable pain and discomfort before dealing with drug side effects.
In the clinical trials, omilancor is being tested for 5 indications – the above mentioned UC and Crohn’s, as well as Eosinophilic Esophagitis (EoE) and in topical cream formulation for psoriasis and atopic dermatitis. The first two indications are the most advanced in the clinical program, with Phase 3 trials underway. The Phase 3 trial of omilancor for UC was initiated in July of this year, after the release of positive Phase 2 data; also in July, Landos received a $3 million grant to continue its studies of omilancor for Crohn’s disease. The company expects to release results from an earlier Phase 2 trial in 1H22.
In another recent pipeline headline, Landos announced in October that the FDA had approved its IND for drug candidate LABP-104, a new systemically distributed LANCL2 agonist to use in the treatment for Lupus. The approval clears the way to begin Phase 1 testing, with topline results from the trial expected in 1H22.
In short, this company has an active research program with multiple tracks advancing simultaneously – and Craig-Hallum analyst Robin Garner takes note of that, saying of the company: “While LABP has multiple programs in parallel, we focus on UC and CD as drivers of a $2B valuation using a SOTP model with 40-50% Probability of Success and 12-15% WACC. We estimate that omilancor could become the standard of care after its potential launch in 2025 given its safety profile and biologic-like activity, with total WW unadjusted revenue of >$3B by 2034 if successful."
"We believe LABP is undervalued at current levels given the existing Phase II data in UC and upcoming Phase III start in Q4 2021," the analyst summed up.
In line with these comments, Garner rates LABP a Buy and his $45 price target indicates confidence in a robust 229% one-year upside. (To watch Garner’s track record, click here)
Overall, with 5 analyst reviews of the stock on file, all positive, the message is clear: LABP is a Strong Buy. Based on the $37.80 average price target, shares could climb 176% higher in the next twelve months. (See LABP stock analysis on TipRanks)
Brilliant Earth Group (BRLT)
Next up, the Brilliant Earth Group, deals in ethically sourced diamonds and gemstones for the jewelry trade. It is a known – and increasingly controversial – fact that many diamonds and gemstones are mined or otherwise sourced from the world’s conflict regions, and that the actual mining is frequently conducted by slave labor, child labor, or both. Brilliant Earth, based in San Francisco, California, was founded in 2005 and has labored to create a gemstone market separate from the so-called ‘blood diamonds.’
In practical terms, Brilliant Earth sources diamonds and other gems from ethically and environmentally responsible producers, and uses blockchain technology to enable tracking and tracing of a stone’s origins. In addition, the company uses a high percentage of recycled precious metals in its jewelry manufacture, to minimize its mining footprint. Brilliant Earth offers its customers a wide range of ‘ethically source jewelry,’ including made-to-order engagement and wedding rings, other jewelry items, and a variety of diamonds and gemstones cut to the buyer’s specifications.
Earlier this year, Brilliant Earth joined the swelling ranks of companies that have taken advantage of the rising markets to raise capital through IPOs. This company’s initial offering was held in September, and the BRLT ticker started trading on the NASDAQ on September 23. The offering saw over 9.58 million shares made available to the public, at a price of $12 per share. Overall, Brilliant Earth raised $115 million in the IPO.
5-star analyst Randal Konik, of Jefferies, initiated his coverage of BRLT with a Buy rating, and his $18 price target implies an upside of 55% over the coming months. (To watch Konik’s track record, click here)
Backing his stance, Konik points out the company’s strong position in some of the traditional metrics of an e-commerce up-and-comer: “Brilliant Earth is a digital-first retailer, and the co's unique tech platform gives it a competitive advantage versus traditional retailers. This starts with its website, which offers dynamic visualization technology, easy to use customization tools and virtual try-on capabilities. It extends to its supply chain capabilities, that offer vast selection (via a low-risk, capital-light virtual inventory model), and lead times that are a fraction of industry norms.”
Looking ahead, Konik is optimistic about BRLT's growth and prospects, noting: "We believe Brilliant Earth has significant runway for both top- and bottom-line growth ahead, given: (1) a large, highly fragmented fine jewelry industry where ~65% of sales come from local, independent operators, (2) multiple top-line drivers including continued e-comm adoption among consumers, significant showroom white space, international expansion, and expanded offerings in the fine jewelry category, and (3) margin expansion opportunities through enhanced pricing algorithms, leverage on fixed expenses, a more efficient marketing strategy and an increased mix of higher-margin fine jewelry."
All in all, Wall Street likes Brilliant Earth, as evidenced by the unanimous 8 share reviews supporting the Strong Buy consensus rating. The stock is selling for $11.57 and its average price target of $16.71 suggests a one-year upside of 47% from that level. (See BRLT stock analysis on TipRanks)
To find good ideas for small-cap stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.
Disclaimer: The opinions expressed in this article are solely those of the featured analysts. The content is intended to be used for informational purposes only. It is very important to do your own analysis before making any investment.