# Uncovering the Small-Cap Investing Opportunity: The Netflix Case Study
In honor of Easter Weekend, we begin a two-part series by Senior Market Analyst Brian Hunt, featuring one of the most astonishing “what-if” investment narratives ever presented.
Imagine transforming a $5,000 investment into $2.87 million – and no, that’s not a mistake…
The early days of Netflix serve as a compelling example of the consequences that can arise when the world underestimates a groundbreaking idea. However, this isn’t solely the story of Blockbuster’s misstep; it’s also a gateway into a crucial yet often overlooked reality in investing.
In the essay that follows, Brian explores how the largest fortunes come not from the biggest stocks, but from identifying opportunities that others may overlook due to pride, delay, or ignorance.
Are you ready to reconsider your approach to finding significant investment victories?
Here’s Brian with Part I of “What Kind of Easter Egg Hunt Are You In?”
Have a pleasant evening,
Jeff Remsburg
In the spring of 2000, a man named Reed Hastings ventured to Dallas with a bold business proposition.
Hastings approached Blockbuster, the leading movie rental company, with an offer. He sought to sell his small enterprise, Netflix, for $50 million.
At that juncture, Hastings’ company had a promising model allowing customers to rent movies via mail. Even though Netflix showed potential, it was still a small player and struggling to achieve profitability.
Hastings believed a partnership with Blockbuster would benefit both parties. However, Blockbuster executives rejected the notion, believing Netflix’s business concept misaligned with their operations. A Netflix executive later recounted that Blockbuster essentially dismissed Hastings’ pitch.
The rest of the saga is likely familiar.
Netflix garnered investment from alternative sources and built a thriving mail-order DVD rental service.
By around 2007, the company made a strategic shift to become America’s top streaming service for movies and television, effectively eclipsing traditional rental giants like Blockbuster.
In 2002, Netflix boasted fewer than 3 million subscribers. Fast forward to 2022, and the figure skyrocketed to 222 million subscribers, with a market valuation of $129 billion.
In comparison, what was Blockbuster’s market valuation in 2018?
Nothing.
It declared bankruptcy long ago, and its decision to pass on Netflix is often cited as one of the most egregious blunders in corporate history.
To illustrate the potential gains from an early investment in Netflix, consider that the stock dropped to a split-adjusted low of $0.35 per share in 2002.
Now, let’s assume you didn’t buy at the low but invested $5,000 when the stock was at $0.50, acquiring 10,000 shares.
By 2022, that initial $5,000 investment would be valued at $2.87 million, delivering a remarkable 574-fold return.
Netflix’s ascent exemplifies one of the most powerful principles in finance and investing.
What is this principle?
To achieve substantial returns in stocks, you must choose the right Easter egg hunt.
Let’s delve deeper into how to identify stocks that can yield remarkable returns.
Identifying High-Potential Stocks
On Wall Street, companies are categorized based on their size.
Typically, investors classify these companies into three categories: large-caps, mid-caps, and small-caps.
The term “cap” stands for “market capitalization.” This term indicates a company’s total value, calculated by multiplying the total number of shares outstanding by the price per share.
The categories make intuitive sense. Large-caps represent the largest companies, small-caps denote smaller firms, while mid-caps fall somewhere in between.
For instance, Microsoft is a prominent large-cap company with a market cap of approximately $1.79 trillion as of November 2022.
Similarly, Apple, as a large-cap company, had a market cap of around $2.4 trillion during the same period.
Mid-caps, typically regarded as those with market capitalizations ranging from $2 billion to $10 billion, are smaller than large-caps.
Notably, the disparity between large-caps and mid-caps can be substantial. A mid-cap company valued at $5 billion is a mere fraction of the size of a tech giant like Microsoft.
On the other hand, small-caps include companies with market caps below $2 billion.
While the gap between mid-cap and large-cap firms can be notable, the difference between small-caps and large-caps can be astounding.
For example, consider a small-cap firm valued at $500 million; this represents just 10% of a mid-cap company worth $5 billion, and is indeed less than one-tenth of one percent of a large-cap like Microsoft.
Large-cap investments can be favorable. These firms generally possess stability, established operations, and profitability, occasionally offering dividends. Therefore, large-caps appeal to conservative investors.
However, if your objective is to achieve returns of 10, 20, or even 50 times your investment (or a staggering 574 times like Netflix), you should focus your attention on small-cap stocks.
Small-cap companies have a far greater capacity for delivering substantial returns to their shareholders in a short timespan than larger corporations.
This is driven by a fundamental fact: a young, $500 million small-cap has the potential to multiply by 10 much more easily than an established $500 billion giant.
This outcome is simply a matter of mathematics.
Consider this analogy: if your daughter sold 10 boxes of Girl Scout Cookies solo, you could help her increase sales tenfold (to 100 boxes) by enlisting friends and neighbors to support her.
However, if she is already a skilled saleswoman who has sold 100 boxes independently, the challenge intensifies; achieving 1,000 boxes becomes significantly harder. This illustrates the mathematical challenge associated with achieving expansive growth when a company already reports significant sales figures.
Think of these scenarios:
- A small beverage company with a $300 million market cap generates a hit product that brings in an additional $1 billion in sales, resulting in a substantial stock price increase of hundreds or even thousands of percent.
In contrast, when a colossal company like Coca-Cola generates an additional $1 billion in sales, its large income statement absorbs the impact with minimal effect.
- A $200 million restaurant chain expanding from 40 to 240 locations could see its market valuation skyrocket. By contrast, when Starbucks opens 200 additional locations on top of its already extensive operations, the impact is negligible.
- A $600 million software company that devises an effective method to manage healthcare or marketing data may boost its revenues by over $1 billion, with stock soaring accordingly. However, for giant Microsoft, adding $1 billion to its already significant annual revenue does not result in the same effect.
Small-Cap Stocks: Uncovering Hidden Potential for Growth
When evaluating investment opportunities, it’s essential to understand the significance of company size. Larger companies, while often stable, may not provide the significant returns that many investors seek in a short time frame. For instance, a $500 million small-cap is merely one-tenth of one percent of a $500 billion large-cap.
This stark difference leads many investors to explore the small-cap stock sector, where remarkable growth potential thrives. These companies have the unique ability to expand by 10, 20, or even 574 times their current size, presenting lucrative investment opportunities.
Understanding the Advantage of Small-Cap Investing
Investing in small-cap stocks offers distinct advantages that large-cap investors frequently miss. One effective way to illustrate this is through an Easter egg hunt analogy.
Imagine it’s Easter morning, and you’re prepared for a neighborhood Easter egg hunt in a local park. Over a hundred eggs, each containing a treat, are scattered throughout. Among those eggs, there’s one special egg that includes a cash prize.
In this hunt, consider these two scenarios:
- There are 1,000 other participants searching alongside you.
- Only 10 others are participating in the hunt.
Most people would prefer the second scenario. Fewer competitors mean a better chance of uncovering those valuable eggs.
In this case, hunting with just ten others is more advantageous than competing against a thousand people.
This principle applies directly to investing. The same dynamics present in an Easter egg hunt play out daily in the financial markets.
On these platforms, millions of investors seek to buy assets below their true value and to sell them above what they’re worth. Everyone is in search of a bargain.
Despite the well-regulated nature of financial markets, opportunities often arise when the pricing of assets falls short of their actual potential. These moments of market inefficiency can lead to significant profits for the keen-eyed investor.
However, high competition in investment markets can diminish the chances of identifying these inefficiencies. More investors conducting meticulous research and analysis lead to tighter pricing and shorter opportunity windows.
Institutional investors, including mutual funds, pension funds, hedge funds, and insurance companies, dominate the market landscape. They act like large elephants, relentlessly searching for investment opportunities. Because of their sheer size and resources, they often manage to overpower smaller investors, making it difficult to find those lucrative market inefficiencies.
In conclusion, while larger companies may often dominate headlines, investing in small-cap stocks can provide avenues for explosive growth. By recognizing the benefits of choosing to navigate the less crowded paths of small-cap investments, you may open doors to opportunities that have substantial potential for reward.
Understanding the Role of Institutional Investors in Today’s Markets
Institutional investors, which include entities like sovereign wealth funds, manage vast sums for nations and large organizations. Their financial reach is substantial, with a single large institutional investor capable of overseeing over $10 billion in assets.
In contrast, even affluent individuals holding $5 million in assets appear minor next to these financial giants—specifically, the institutional investors are about 2,000 times larger by comparison.
Many institutional investors operate with significantly higher amounts than the $10 billion mark. For instance, Norway’s sovereign wealth fund, significantly bolstered by years of oil revenue, exceeded $1 trillion in 2017. This amount dwarfs the assets of larger institutions by 100 times.
The world’s major institutional investors possess enormous capital for investments in stocks, bonds, and various assets.
Typically, these large investors employ extensive teams of analysts who dedicate countless hours each year identifying market opportunities. Their process resembles traditional “financial detective” work, involving visits to public companies and discussions with industry experts.
In addition, these professionals utilize advanced computer algorithms and “Big Data” analytics to evaluate market information. The algorithms operate continuously, analyzing global financial data in numerous ways to uncover pricing inefficiencies, whether small or significant.
Think of it as an Easter egg hunt—one that is particularly competitive.
While this competitive nature poses significant challenges, the financial market remains expansive and varied. This diversity presents opportunities that institutional investors cannot always access.
We’ll pause our discussion here for today and continue our exploration tomorrow.
Regards,
Brian Hunt
Senior Analyst, InvestorPlace
P.S. – Seeking assistance in this competitive “Easter Egg Hunt”?
Artificial intelligence (AI) has played an evolving role on Wall Street, especially in targeting lucrative investment opportunities. In recent years, the industry has made substantial investments in AI technology, reaching hundreds of millions of dollars for its development.
For individual investors, this is where TradeSmith’s innovative AI algorithm, named An-E, comes into play. This tool can predict share prices for thousands of stocks, funds, and ETFs one month ahead.
On Wednesday, TradeSmith CEO Keith Kaplan provided insights on this groundbreaking system and demonstrated its application for enhancing investment strategies.
If you missed it, you can watch a free replay of Keith’s AI Predictive Power Event right here.
