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The Next Great Growth Stock

The next great growth stock is a cloud-based market leader in the nonprofit fundraising industry. And it’s already grown too big to remain in my small-cap portfolio.

There’s a small cap stock I’ve been high on for years, but has now grown so much that it no longer qualifies as a small cap. That said, I think it’s in the midst of becoming the next great growth stock.

I’ll reveal the stock in a bit. But first, a story…

This past Saturday morning was very different from my typical weekend morning. Instead of cheffing up breakfast for the family or heading to the beach early to avoid the crowds, my wife and I headed down to the Newport, Rhode Island Naval Station. The base has been used by the U.S. Navy since 1883, and was the jump off point for the 40th Annual Save the Bay Swim, a 1.7-mile swim across Narragansett Bay, from Middletown, RI to Jamestown, RI.

I was swimming, and my wife was my kayak escort.

This was my first swim, and the topic was a good conversation starter at last week’s Cabot Investors Conference, which Cabot hosted in Salem, Mass. In addition to a lot of encouragement (thank you!), I was frequently asked, “Are you nervous?”

The honest answer was, of course, “You bet!” Swimming out in the deep ocean isn’t exactly something I aspired to do before signing up for the swim on an impulsive spring morning. The chances of encountering a hungry shark were slim to none, especially with all the other swimmers and boats in the water. But still, it’s over 130 feet deep out there! Every so often a whale is spotted, there’s a lot of fishing activity and there’s a decent seal population (mainly in the winter). So it’s not as if there’s not enough room—or food.

Fortunately, shark sightings on the Rhode Island coast are rare.

It’s not like eastern Cape Cod. And I’m not aware of any Great White sightings in Narragansett Bay. So truth be told, I wasn’t all that nervous about sharks beforehand. The easygoing nature of all the more experienced swimmers at the starting line evaporated any remaining unease (and I admit to thinking at least a few looked like better meals than me). And once the cannon signaled the start, I was far more concerned with sucking in a mouthful of water or getting a bad leg cramp (I had a few mild ones) than about becoming fish food.

It was a beautiful, windless day and I made it across safely in one hour and 15 minutes. My wife had a great paddle. Combined, our team helped raise over $250,000 to protect and improve Narragansett Bay. And we received free t-shirts, a new beach towel and ice cream at the finish line. Well worth it!

Invest in What You Discover

So what does this have to do with investing? A lot, actually.

One of the most underrated methods for discovering high-potential small cap stocks is also the most rewarding, both literally and figuratively. It’s not a complex screen, and doesn’t require any number crunching or algorithms. Or even a computer.

It just requires that you think about the companies, products and brands you interact with. And blend that power of observation and curiosity with a little research. This isn’t the old Peter Lynch mantra to “invest in what you know.” This is different. More like, “invest in what you discover.”

And to be perfectly clear, I’m not referring to well-known companies here, like Facebook (FB) or Apple (APPL). Those are far too obvious. In contrast, many small cap stocks have products and services that are far less well known (if they’re known at all), and some digging is required to uncover the company responsible. But that work can be well worth it if you find the next great growth stock.

This was how I came across Blackbaud (BLKB) a number of years ago (at a different fundraising event). Blackbaud is the market leader in the nonprofit fundraising industry. Its software is used by Save The Bay. And the cloud-based business model is perfectly suited to helping a lot of individuals raise small chunks of money to support a larger cause. Because it offers fast, flexible and secure access for users, its use of cloud software is growing extremely quickly. In fact, it’s growing even more quickly than expected just a few years ago.

For the industry as a whole, one research firm just increased its software-as-a-service and cloud software forecasts after seeing much stronger growth in 2015 (26% year-over-year growth) than previously forecast (18.6% year-over-year growth). Perhaps more important for investors, IDC sees cloud software revenue growth picking up from 2016 to 2020, driven by a mix of global market mega-trends, growth of digital business and customer recognition of the tangible benefit of cloud software deployments.

The message to investors is that the shift to cloud software is still in its early innings, and that it’s a very real, very big, and very lucrative market to consider investing in. These were the reasons I became interested in Blackbaud a few years ago. Had I not entered the running event that relied on the company’s software, I might never have known it even existed.

Blackbaud is the only publicly traded, pure-play provider of software and services for the worldwide philanthropic community. It has over 30,000 customers ranging from very small, local charities to very large, international relief organizations from a wide spectrum of industry segments, including health care, education, faith-based and arts and culture. Its products are popular and the customer base is wide.

Today, with a market cap of $3.2 billion, the company has grown toward the upper end of the small-cap spectrum. That’s a direct result of the software helping clients promote their causes, manage relationships and finances, conduct marketing and social media activities, and analyze market opportunities and data trends. Growth has been steady.

Blackbaud is the market leader in the nonprofit fundraising industry, and there is still a lot of room for expansion. The big picture trend for gift giving is about as solid as they come. And Blackbaud’s size and wide scope of product offerings means the company is well positioned to expand into adjacent markets, the latest of which is an expansion into K-12 education.

Until recently, it was included in the Cabot Small-Cap Confidential 2.0 portfolio. But I recommended that subscribers sell all or part of their position to lock in a market-beating gain.

That wasn’t because it’s not a good company. But because with a market cap of $3.2 billion and annual revenue growth expected to be around 12% for the next two years, Blackbaud has now become a little too conservative to meet my aggressive growth standards (I know several subscribers elected to hold on to their position, since Blackbaud’s profile still meets their criteria).

Blackbaud has been a good investment, and I think it’s well on its way to becoming the next great growth stock. But for Cabot Small-Cap Confidential 2.0 subscribers, my job is to uncover the next group of Blackbaud’s – companies that are just entering their supernormal growth phase. I think I’ve uncovered just the ticket with one in particular. This software stock is in a different industry from Blackbaud, and is growing revenue by over 35% annually. I featured it in the August Issue of Cabot Small-Cap Confidential 2.0. And at our recent Cabot Investors Conference, this was my “top pick” for the next year.

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Tyler Laundon is chief analyst of the limited-subscription advisory, Cabot Small-Cap Confidential and grand slam advisory Cabot Early Opportunities. He has spent his entire career managing, consulting and analyzing start-up and small-cap companies. His hands-on experience has taught Tyler that the development of a superior business model is the biggest factor in determining a company’s long-term success. Accordingly, his research focuses on assessing the viability of management’s growth strategies, trends in addressable markets and achievement of major developmental milestones.