Many small-cap stocks have limited Wall Street coverage, giving savvy investors the chance to act before everyone else catches on. But the flip side is that these businesses have increased downside risk because they lack the scale and staying power of their larger competitors.
The downside that can come from buying these securities is precisely why we started StockStory - to isolate the long-term winners from the losers so you can invest with confidence. Keeping that in mind, here are three small-cap stocks to avoid and some other investments you should consider instead.
Couchbase (BASE)
Market Cap: $759 million
Formed in 2011 with the merger of Membase and CouchOne, Couchbase (NASDAQ: BASE) is a database-as-a-service platform that allows enterprises to store large volumes of semi-structured data.
Why Are We Wary of BASE?
- Revenue increased by 19.2% annually over the last three years, acceptable on an absolute basis but tepid for a software company enjoying secular tailwinds
- Long payback periods on sales and marketing expenses limit customer growth and signal the company operates in a highly competitive environment
- Poor expense management has led to operating losses
Couchbase’s stock price of $14.46 implies a valuation ratio of 3.3x forward price-to-sales. To fully understand why you should be careful with BASE, check out our full research report (it’s free).
DigitalOcean (DOCN)
Market Cap: $3.49 billion
Started by brothers Ben and Moisey Uretsky, DigitalOcean (NYSE: DOCN) provides a simple, low-cost platform that allows developers and small and medium-sized businesses to host applications and data in the cloud.
Why Does DOCN Give Us Pause?
- Customers have churned over the last year due to the commoditized nature of its software, as reflected in its 97.5% net revenue retention rate
- Gross margin of 59.7% is way below its competitors, leaving less money to invest in areas like marketing and R&D
DigitalOcean is trading at $37.95 per share, or 4x forward price-to-sales. Check out our free in-depth research report to learn more about why DOCN doesn’t pass our bar.
The Honest Company (HNST)
Market Cap: $560.9 million
Co-founded by actress Jessica Alba, The Honest Company (NASDAQ: HNST) sells diapers and wipes, skin care products, and household cleaning products.
Why Does HNST Worry Us?
- Muted 5.9% annual revenue growth over the last three years shows its demand lagged behind its consumer staples peers
- Subscale operations are evident in its revenue base of $378.3 million, meaning it has fewer distribution channels than its larger rivals
- Suboptimal cost structure is highlighted by its history of operating losses
At $5.12 per share, The Honest Company trades at 21.7x forward EV-to-EBITDA. Read our free research report to see why you should think twice about including HNST in your portfolio.
Stocks We Like More
The Trump trade may have passed, but rates are still dropping and inflation is still cooling. Opportunities are ripe for those ready to act - and we’re here to help you pick them.
Get started by checking out our Top 6 Stocks for this week. This is a curated list of our High Quality stocks that have generated a market-beating return of 175% over the last five years.
Stocks that made our list in 2019 include now familiar names such as Nvidia (+2,183% between December 2019 and December 2024) as well as under-the-radar businesses like Axon (+711% five-year return). Find your next big winner with StockStory today for free.
