Small-cap stocks have the potential to deliver huge returns. However, smaller companies can be extremely volatile and I'll admit that I've had my fair share of small-cap losses over the years.
I now steer clear of stocks that are generating intense bulletin board speculation, and focus on companies that are quietly generating consistent revenue and earnings growth. I've found this method dramatically reduces the chance of investing in a company that goes on to lose the majority of its value.
There are some really interesting opportunities in the small-cap technology sector at the moment - here are four stocks that I like.
Dotdigital Group(LSE: DOTD) is a leader in the digital marketing space with the company's key product Dotmailer enabling clients to send customised marketing emails within minutes.
A trading update released last week was excellent, with management stating that revenue is likely to jump 26% year on year and that EBITDA will be ahead of market expectations. The company also noted that average revenue per client was up 29%.
Revenue has grown from £12.2m in FY2013 to £24.2m in FY2015. With email remaining a popular form of communication between companies and their customers, I believe there's more to come from Dotdigital, even though the company trades on a high P/E ratio of 26.9 times next year's earnings.
Proving your identity online has generally become a lot easier in recent years and identity specialist GB Group(LSE: GBG) is at the heart of this process. GB Group combines trillions of data records from all over the world relating to people's identity to help its clients make the right decisions about the customers they serve.
Results in June revealed that revenue rose 28% year on year, including organic revenue growth of 16%. Adjusted earnings per share were up 34%.
Revenue has climbed from £24.2m in FY2011 to £73.4m in FY2016 - a compounded annual growth rate of almost 25%.
GB Group has traditionally traded on a high P/E ratio (currently 29 times next year's earnings), but this is a company with strong momentum delivering annualised returns of 45% per year to shareholders over the last five years.
With cyber hacks becoming more frequent, business is booming at cyber security specialist NCC Group(LSE: NCC). Indeed, recent results revealed that revenues were up 56% on last year, including 19% organic growth.
Earnings have grown from 5p per share in FY2011 to 9p for FY2016 and growth shows no sign of slowing down with analysts estimating FY2017 earnings of 12p. A P/E ratio of 25 times next year's earnings reflects a quality company operating in a high growth area.
Rise of the machines
Earlier this week it was announced that Japanese company SoftBank had shelled out a whopping £24bn to purchase ARM Holdings, looking to capture "the very significant opportunities provided by the Internet of Things". There's no doubt machine to machine communication is a exciting growth area and if you're looking for small cap exposure, check out Telit Communications(LSE: TCM).
Revenue at Telit has grown from £177.4m in FY2011 to £333.4m in FY2015 and while a profit warning in October dampened enthusiasm towards the stock, the share price now appears to be trending up again.
City analysts expect growth to pick up in the second half of this year and with the stock trading on P/E ratio of 13.9 times next year's earnings, now could be a good time to take a look at this IoT specialist.
Under the radar winner
The four stocks above all trade on high valuations that can be off-putting for some investors.
If you're looking for a small cap stock showing similar momentum but trading on a much lower valuation, I urge you to download this report here: 1 Top Small-Cap Stock From The Motley Fool.
While I can't give the name of this company away, I can inform you that The Motley Fool team believes this company has excellent growth potential, and yet it's trading on a P/E ratio of just 11.
Edward Sheldon owns shares in Dotdigital Group and NCC Group. The Motley Fool UK owns shares of NCC. The Motley Fool UK has recommended ARM Holdings. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.