Most growth investors today are looking for that small company that delivers massive returns. After all, such powerhouses have to start somewhere—Amazon and Netflix once had market capitalizations below $1 billion.
Identifying these future winners while they are still at the small cap stage is extremely challenging. Once they become mid-cap stocks, with market caps in the $2 billion to $10 billion range, they can be a bit easier to spot. Obviously, no one can guarantee that such a company will lead its industry segment or become a multi-bagger. But in the opinion of three Motley Fool contributors, these three companies have blazed a trail that could get them to that level.
Already growing by leaps and bounds, Duolingo could one day become the world's education platform
Jake Lerch (Duolingo): Okay, let me be clear: In order for language learning platform Duolingo to generate truly massive revenue, it needs to grow -- a lot. Duolingo (NASDAQ: DUOL ) currently has a market cap of $6.5 billion. Even if it quadrupled its market cap to $26 billion, it would still be only about a tenth the size of more established tech stocks like Netflix.
To grow, Duolingo will need to put the pedal to the metal on many fronts. Let's start with the obvious: They need to increase their revenue stream, which can happen in part by growing the app's paid subscriber base. So far, so good: Paid subscribers grew 63% year-over-year to 4.8 million at the end of the first quarter of fiscal 2023.
Selling more features in the app will also help in revenue growth and progress has been made in this area as well. Total bookings jumped 37% in the same year-over-year period, bringing in $140.1 million in the latest quarter. However, this growth can only continue if Duolingo sees a jump in user numbers.
As of Q1 FY2023, Duolingo has 72.6 million monthly active users (MAUs). That's a year-on-year increase of 47%. But for Duolingo to take things to the next level, that number will have to snowball.
Fortunately for the company, not many people have heard of Duolingo, let alone tried its product, which means the company has impressive growth. As more people engage with artificial intelligence (AI) chatbots like ChatGPT, the appeal of Duolingo's AI-based learning app should increase.
What's more, there's nothing stopping Duolingo from expanding beyond language education. The company's mission statement states that it aims to "develop the best education in the world" — not just language education, but all education.
Suppose a company can increase its user base and revenue by developing cutting-edge educational software that uses advanced artificial intelligence. In that case, Duolingo could become the leading educational platform worldwide, bringing significant profits to early investors in the process.
A $45 trillion market with limited competition? Yes please.
Justin Pope (Opendoor Technologies): Buying and selling a home is probably the most important transaction in most people's lives, but it's also notoriously stressful. The general home buying process hasn't changed much in many decades, but Opendoor (NASDAQ: OPEN ) wants to bring home buying into the 21st century. She pioneered iBuying, in which companies buy homes from consumers and resell them on the market. Opendoor offers sellers convenience and speed, and charges less than traditional real estate agents.
The market opportunity is huge. American homes are worth a total of $45 trillion, and inventory is always slowly turning over as people move. Opendoor currently serves only a small slice of that market, generating $13.5 billion in revenue over the past year. Room for expansion is obviously room. It is not a risk-free investment; Opendoor relies on small gross margins because you can't rip people off with super profitable home offers and expect to close many deals. However, getting the price wrong can have disastrous consequences. Opendoor tried to expand too quickly and mispriced many homes when the market cooled in early 2022, losing hundreds of millions of dollars in inventory write-downs.
However, after replacing the CEO with former CFO Carrie Wheeler, the company has recovered from this misstep and is heading back in the right direction. A tough housing market forced competitor Redfin out of the iBuying game, and in August 2022, Opendoor joined forces with former iBuying competitor Zillow in a partnership that's still ongoing and could boost its business.
The company currently has a market value of just $3 billion. While iBuying isn't the future of all home buying, the addressable market is large enough for Opendoor to be a niche business within its industry and still grow to several times its current size. The company still needs to make a consistent profit, which makes Opendoor a more speculative investment idea today. However, owning just a small piece of this company could be very rewarding if Opendoor can realize and realize its full potential.
The cloud stock of small businesses headed for smooth waters
Will Healy (DigitalOcean): Admittedly, DigitalOcean (NYSE: DOCN ) may seem like a bad choice in terms of size. With a market cap of just over $4 billion, it competes with the likes of Amazon, Microsoft and other cloud giants that have market caps more than 200 times larger.
However, it has used its smaller size to offer two key competitive advantages to its customers.
First, it publishes all of its prices online. This creates a simple interface where small and medium-sized businesses (SMBs) can purchase only the cloud services they need. This approach is likely to make many SMBs choose DigitalOcean to keep costs down.
Second, the DigitalOcean community is a key asset. If a customer has an IT-related problem, this community offers an extensive library of documentation. Customers can also reach out to other members of the DigitalOcean customer base who may be able to offer solutions. This is critical because many DigitalOcean clients may have one-person IT departments or even rely on a single employee who is already handling other tasks within the business. Community increases the likelihood that a company can solve IT-related problems in a cost-effective manner.
Through these customers, DigitalOcean believes its total addressable market will reach $195 billion by 2026, representing a compound annual growth rate of 26%. Its revenues now give it less than a 1% share of that potential market. In the first quarter of 2023, its revenue was $165 million, up 30% from the same quarter last year.
It actually lost $35 million in the first quarter as stock-based compensation, restructuring costs and other expenses weighed on its bottom line. However, its non-GAAP net income of $29 million more than tripled from a year ago.
Additionally, the company estimated 2023 revenue of $710 million on Wednesday, which would be a 23% increase from 2022. If it keeps up this pace, it could reach GAAP profitability for the foreseeable future.
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