Small-caps are an excellent way to improve your wealth. Due to the smaller, generally higher-growth nature of small-caps, they tend to produce better returns than bigger blue-chip peers. Indeed, some of the world's most famous investors made their fortunes investing in small-caps. However, even though smaller firms may come with the potential for higher returns, this additional profit potential also comes with added risk, and this may not be suitable for all investors.
The best way to mitigate the extra risk is to combine small-caps with slow and steady blue-chips in your portfolio, and two companies that look to be perfect for such a combination are GlaxoSmithKline and Sinclair Pharma(LSE: SPH).
Hidden growth stock
Sinclair Pharma is a relatively complicated business to understand, that seems to be why it falls under the radar of most investors.
The company sold its healthcare products business to fellow UK-listed firm Alliance Pharma in December 2015. This left Sinclair focused on its aesthetics products business, which is still in its early stages but is growing rapidly. For the year to the end of December 2016, revenue for the aesthetics business rose 51% to £37.8m thanks to a boost from its Silhouette Soft skin lifting and repositioning product which launched in the US during August and saw overall sales for the year grow by 51%. Ellanse, the firm's collagen stimulator product, saw revenue rise 42% thanks to growth in South Korea and Spain.
Nonetheless, despite this rapid revenue growth, Sinclair is still lossmaking. The firm reported a pre-tax loss of £11.6m. For 2015 the company reported a loss of nearly £30m, so the figures are heading in the right direction. City analysts believe the company's loss will contract further this year, with a pre-tax loss of £3.8m projected. Analysts currently expect the group to break into profit next year with a pre-tax profit of £4.6m expected on revenue of £62m.
If Sinclair's growth continues at its current rate, there is a very real chance that the company could become one of the UK's largest pharmaceutical groups. A buyout is also likely, and Glaxo could be the firm's perfect suitor. It already has a large consumer pharmaceutical business and bolting on Sinclair's aesthetics products wouldn't be difficult for management.
This may not be the best case for shareholders. As a standalone business, based on historic growth rates, shares in Sinclair could rise by more than 50% over the next few years as growth comes through. Based on the performance during the past three years, £10m of additional revenue has translated into around £10m of additional pre-tax profit. If revenue hits £70m during 2019, pre-tax profit of £14m could be on the cards, which works out at around 2p in earnings per share. A multiple of 20 times earnings on this target indicates a share price of 40p, 25% above current levels. But considering the firm's growth and multiple of 30 times, it may be more appropriate giving a share price of 60p, up 90% from current levels.
When investing in small-caps, diversification is key and if you're interested in Sinclair, it might be best to combine the stock with another small-cap champion in your portfolio.
And if you're struggling for ideas, the Motley Fool's top analysts have recently labelled this stock as one of the market's "top small-caps".
Rupert Hargreaves owns shares of GlaxoSmithKline. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.