3 Small Cap Stocks That May Someday be Large Caps

It's often a long journey for a stock to go from a small-cap to a large-cap, let alone to a mid-cap. Many try, but few succeed. Those that do typically have some sort of sustainable competitive advantage or groundbreaking product that propels them into the big leagues. Sometimes is more a matter of being in a high-growth market.

U.S. small-cap stocks are already up more than 20% year-to-date outpacing their large-cap counterparts by a four-to-one margin. This has some investors hunting for smaller companies to infuse some growth into their portfolios. Here we highlight three small caps that not only have the potential to outperform their peers but turn into the next generation of large caps.

 What is Behind Growth at Palomar?

Palomar (NASDAQ:PLMR) is a fast-growing insurance company that specializes in catastrophe insurance for commercial and personal properties. Since going public in April 2019 Palomar shares have climbed from less than $20 to more than $120 before taking a breather. Now trading around $70 per share, the stock is back in small-cap territory where it may not be for long.

The catastrophe portion of the broader U.S. property and casualty insurance market is estimated to be a $30 billion opportunity. Much of this relates to potential earthquakes, hurricanes, and other natural disasters. Palomar sits in a favorable spot in this market because it is one of the largest underwriters of earthquake insurance in the country.

For many homeowners and businesses located in Palomar's home base of California, earthquake insurance is a must-have. Across the pond in Hawaii, hurricane-related insurance is similarly essential. Palomar is also one of the leading hurricane and flood insurance companies in Hawaii.

Sales growth was 53% last year and is forecast to be above 30% in each of the next two years as Palomar spreads it wings geographically. Profits are also forecast to be strong due high policy retention rates and rate increases. Higher pricing and rising demand for catastrophe insurance from businesses and retail customers could be the perfect storm that sends Palomar stock to large cap status.

What is a Good e-Commerce REIT?

Industrial Logistics Properties Trust (NASDAQ:ILPT) is a REIT that leases industrial and logistics properties. It owns close to 300 properties that are 98.5% leased to some 273 different tenants. It doesn't get much more diversified than that when it comes to maintaining a broad tenant base. Not having a dependence on any one customer or customer type is a major attraction for the REIT along with its 9.5 year weighted average remaining lease term.

Another unqiue aspect of the company is that roughly half of its revenue comes from properties located in the high rent district of Oahu, Hawaii. Tourism is often the first industry that comes to mind with Hawaii, but there is actually a growing need for warehouses and distributions center space to meet consumer and businesses demand from natives and travelers alike.

Back on the mainland, the accelerating shift from traditional retail to e-commerce is driving increased demand for industrial properties. This is where ILPT is putting much of its attention and where most of its growth will come from in the next few years.

After getting slammed with the rest of the real estate sector at the onset of the pandemic, the stock has clawed its way back to where it debuted on the Nasdaq in January 2018. Where does it go from here? Chances are it goes much higher. A recovering economy and elevated level of e-commerce activity should be the perfect backdrop for improving demand for industrial property.

As is typical with REITs, an ILPT investment comes with a sizeable dividend which presently amounts to a 5.7% yield. This along with the ILPT's potential to grow alongside e-commerce growth suggests investors should get in while it is still a small cap.

Is Pennant Group Stock a Buy?

The Pennant Group (NASDAQ:PNTG) is another stock that has come out of the gates strong. After its October 2019 IPO at just above $6, the healthcare company saw its shares rise tenfold before correcting back into the $40's.

Investors may want to keep this future large cap on their radar as a diversified play on the aging U.S. population theme. The company operates hospice agencies, senior living communities, and memory care facilities for American seniors. It also provides home health services to children through its Pediatric Care division.

The Pennant Group's 80 home health and 54 senior living communities are located in 14 western and midwestern states. This gives it a revenue model that is well-diversified both by service type and geography. For the ten-year period through 2020, revenues grew 32% annually through organic and inorganic means.

While it is well known that senior living and home care are expected to remain high growth markets this decade, The Pennant Group's M&A prospects are equally compelling. About 80% of home health, hospice, and senior living organizations are owned by smaller, independent companies. This means it is still a highly fragmented industry that larger operators like The Pennant Group will have ample opportunity to consolidate.

The Pennant Group's track record of growth and opportunities for expansion in multiple high growth markets make it an attractive aging demographic play. As time goes on, we are likely to see this stock age into a large cap.