2 Top Small-Cap Stocks to Buy in August

By Markets Fool.com

Many conservative tech investors tend to stick with "big brand" mega cap stocks like Apple, Microsoft, andIBM. There's nothing wrong with buying these stocks as steady income generators, but the chance that they will double over the next few years is relatively small.

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Therefore, more growth-oriented investors should focus on small cap stocks (which have market caps between $300 million and $2 billion) instead. These stocks generally have a better shot at turning into "multibaggers", because they haven't run out of room to grow. Let's examine two under-the-radar stocks that fit that description -- Carbonite (NASDAQ: CARB) and Silver Spring Networks (NYSE: SSNI).

Carbonite: A niche player in a crowded market

Carbonite provides cloud backup and disaster solutions to enterprise customers. Competition is fierce in that market, but Carbonite serves a niche of SMBs (small and medium sized businesses) instead of larger customers. Many of its bigger rivals focus onsecuring big contracts at large companies, but those pricing plans generally aren't economical for smaller companies with fewer than 300 employees.

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Investor J2 Global (NASDAQ: JCOM) tried to buy Carbonite twice -- once in 2012 and again in 2015 for $366 million -- but the company rejected both bids, declaring that its focus on SMBs would generate better returns for shareholders than a quick sale.

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Carbonite's growth this year indicates that strategy is paying off. Revenue rose57% annually to $53.4 million last quarter as bookings soared 50% to $53.7 million. That growth represents an acceleration from its 46% sales growth in the previous quarter and 12% sales growth in the prior year quarter. Carbonite expects its full year revenue to rise 41%-48%, compared to11% growth in 2015.

Carbonite posted net earnings of $0.04 per share last quarter, compared to a net loss of $0.18 in the prior year quarter. Non-GAAP earnings rose from a loss of $0.01 per share last year to a profit of $0.19, beating estimates by a whopping $0.16. It also expects its non-GAAP EPS to surge 220%-247% this year to $0.48-$0.52.

Analysts expect Carbonite to grow its annual earnings by 30% over the next five years, which gives it a 5-year PEG ratio of 0.9. Since a PEG ratio below 1 is considered undervalued, Carbonite looks cheap relative to its long-term growth potential.

Silver Spring Networks: An investment in smarter cities

Silver Spring Networks sells smart grid products which wirelessly transmit data between electric meters, EV charging stations, smart thermostats, and in-house displays over large areas for companies and consumers. Silver Spring's customers include major utility companies like Consolidated Edison (NYSE: ED), Pacific Power, andAmerican Municipal Power.

The company benefits from the expansion of smart cities, improvements in infrastructure, and the growth of the Internet of Things (IoT), which connects mobile devices, wearables, smart appliances, cars, and other objects to each other and the cloud. Research firm Markets and Markets estimates that the smart cities market will grow from $312 billion to $758 billion between 2015 and2020, while Cisco sees the number of connected devices worldwide doubling from 25 billion to 50 billion during the same period.

Image source: Getty Images.

Silver Spring's growth reflects that demand. Revenue surged 58% annually to$122 million last quarter, representing a major acceleration from 9% sales growth in the previous quarter and flat growth a year ago. The company's number of cumulative network endpoints rose 13% annually to 24.3 million. Silver Spring's shift toward cloud-based services has expanded its margins, enabling it to post a GAAP profit of $0.50 per share last quarter compared to a net loss of $0.32 per share. Non-GAAP earnings stayed flat at $0.02, but beat Wall Street expectations by seven cents.

Silver Spring expects billings to accelerate in the second half of the year, and analysts expect that growth to boost the company's full-year non-GAAP earnings by 56% this year and 107% next year. Those growth figures make its current P/E of 10 and forward P/E of 47 look relatively cheap.

The key takeaway

Carbonite and Silver Spring Networks both have healthy growth numbers, but investors should mind the risks of owning small cap stocks. Trading volumes are generally light, which means that positive or negative headlines can cause sudden spikes or plunges which aren't based on fundamental issues. But for investors willing to ride out that volatility, these two stocks could offer plenty of upside potential over the next few years.

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Leo Sun owns shares of Cisco Systems. The Motley Fool owns shares of and recommends Apple. The Motley Fool owns shares of Microsoft and has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. The Motley Fool recommends Cisco Systems. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.