The small cap sector is predicted to emerge as the it investment theme for 2024, despite the ongoing geopolitical volatility. Market watchers believe that rising expectations of stabilizing or even falling interest rates by the end of the year, coupled with improvements in inflation, will create a favorable environment for smaller companies. Cheaper finance options will benefit smaller businesses with weaker balance sheets, while lower interest rates will also boost disposable consumer income, particularly benefiting smaller retailers.
Tobias Yao, a portfolio manager at Wilson Asset Management, expects a robust year for small-cap stocks due to their underperformance since 2021 and the potential for a rebound. Roger Montgomery, another prominent fund manager, agrees and highlights the agility of small-cap stocks in swiftly responding to positive narratives and shifting sentiment.
The small-ordinaries index has declined approximately 12% since the beginning of 2022, in contrast to the all-ordinaries index, which has gained around 10%. This significant underperformance of 22% is the most pronounced since the Global Financial Crisis when small-cap stocks experienced a surge.
On the other hand, ASX 200 stocks are considered expensive, trading at an earnings multiple of 16 times compared to the historical average of 14.8 times. This divergence has contributed to the growing interest in small caps, particularly among smaller retailers.
The positive outlook for small-cap stocks has been evident since late October, notably among smaller retailers. The Australian Bureau of Statistics reported record retail sales of $36.5 billion in November, a 2.2% increase year-on-year. Furniture and homewares companies such as Adairs, Nick Scali, and online retailer Temple & Webster are expected to benefit from this trend.
Michael Carmody from Centennial Asset Management recommends Beacon Lighting as a housing-exposed small-cap stock. In the tech space, he suggests considering mining services provider RPM Global and compliance company Ansarada.
However, it’s important to note that not all small caps are equal, and selecting the right stocks is crucial. There are inherent risks associated with smaller companies, and even amidst a positive market environment, poorly-performing small caps may not experience significant changes.
To increase the chances of success, Tobias Yao looks for founder-led businesses with significant scale, strong organic growth, and a healthy balance sheet. Companies that meet these criteria could be considered high potential investments in the small-cap space.
Yao highlights Singapore telco Tuas, which was demerged from TPG Telecom after TPG merged with Vodafone Hutchinson Australia. Tuas, the fastest-growing telco in Singapore, has gained a 10% market share over four years by offering better value for money. Additionally, Temple & Webster, the largest online retailer, is enjoying the benefits of scale and AI initiatives, enabling it to capture market share from traditional retailers. Regis Healthcare, the only ASX-listed aged care provider following the merger of Estia Health by Bain Capital, is poised to benefit from the aging population and consolidation in the sector.
It’s essential to conduct thorough research and seek independent advice before making any financial decisions. Small-cap investments can be rewarding but also come with inherent risks. With careful evaluation and selection, investors can seek opportunities within the sector.
