Though small-cap stocks tend to outperform large-caps as a collective investment class, that truism hides a key risk when investing in small-cap stocks. There’s little barrier to entry, practically speaking, to public listing (and the few barriers are easily avoided, as in the case of SPAC mergers). This means that companies with limited prospects or long-term potential can achieve public stock exchange status, giving them an undeserved air of legitimacy.
Each of these three small-cap stocks to sell has inherent and structural weaknesses that will be tough to overcome. Invest at your own risk – but if it were me, I’d avoid each of these small-cap stocks like the plague.
Grom Social Enterprises (GROM)
Grom Social Enterprises (NASDAQ:GROM) is hanging on by a thread, making it top on our list of small-cap stocks to sell. The company positions itself as a safe social network for children, which isn’t a particularly compelling value proposition. Kid-friendly alternatives that offer more engaging features already exist, like Roblox (NYSE:RBLX).
Instead, Grom combines many of the top features you find in existing social stocks like those Meta (NASDAQ:META) offers and delivers them to children. Children, of course, are an advertiser’s dream but tend to have low conversion rates when necessary financial protections are put in place. Bottom line, relying on kids swiping parental credit cards is a poor advertising strategy. To that end, it’s obvious why GROM’s sales are slipping, as they dropped by nearly half in the most recent quarter.
While the company did secure a $4 million private placement deal late last year, don’t expect that to save the stock. That capital will likely disappear quickly based on its balance sheet, which shows nearly $1 million in accounts payable and about the same amount in dividends owed. Working capital is tough to come by, and GROM seems as though it is grasping at straws.
Udemy (UDMY)
As great an idea as Udemy (NASDAQ:UDMY) may be, the fact stands that, in an era of free learning opportunities everywhere, expecting customers to fork over cash for information they could get on YouTube (or a book!) for free isn’t practical. And, though the small-cap stock may have a handful of big-name corporate clients like AT&T (NYSE:T), bigger firms will likely increase in-house production for mandatory training and similar coursework Udemy offers.
Most concerning is Udemy’s “stickiness” with existing customers. The company boasted a 13% increase in total enterprise customers and a 25% increase in recurring revenue in the previous quarter’s filing. Good news, right? Not so fast.
Udemy also reported a 9% drop in net dollar retention (how long customers stick around) and a 10% drop in large customer net dollar retention (UDMY defines large customers as companies with 1,000 or more employees). Both stats indicate that, once they get what they need, companies aren’t sticking around for further service – which doesn’t bode well for Udemy as it struggles to differentiate itself in a competitive EdTech landscape.
Affirm Holdings (AFRM)
Affirm Holdings (NASDAQ:AFRM) may seem a strange pick on a list of small-cap stocks to sell, considering its strong performance this year (up 176% since February 2023) and the fact that its $11.6 billion market cap puts it in the questionable small/mid-cap status range. Still, this stock is one you should sell stat – it’s destined for tough times ahead.
Affirm’s cornerstone service, buy now, pay later (BNPL), offers consumers instant micro-loans at purchase points. Recognizing that BNPL schemes often attract consumers with lesser creditworthiness is key to understanding what lies ahead for AFRM. With a noticeable uptick in credit card delinquencies, the likelihood of Affirm facing unpaid BNPL loans is high.
A closer look at Affirm’s recent financial disclosures unveils a worrying $30 million increase in its provision for credit losses (reserves for expected loan defaults) from one quarter to the next, notably before the peak holiday shopping period. This period likely saw an increase in consumer reliance on Affirm’s BNPL offerings, further stretching their financial commitments. Given the current consumer financial behaviors and broader economic indicators, Affirm’s outlook appears challenging, making it a tough small-cap stock to get behind.
On the date of publication, Jeremy Flint held no positions in the securities mentioned. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.