WHY SMALLER COMPANIES

DIVERSIFICATION AND GROWTH POTENTIAL

Providing added diversification, small-cap stocks can temper the exposure most Australian indices and lage-cap managed funds have to banks and resource stocks. For example, the financials (ex property) sector alone, which include banks, makes up over a third of the S&P/ASX 100 index.

A challenging domestic economy has created a difficult operating environment for many of the larger companies listed on the ASX, including the major banks. The beauty of small-cap investing is that despite the structural and macro issues facing the broader economy, it is possible to find small-cap companies that are performing well and off much lower earnings bases than their larger peers.

Greater growth potential
Smaller companies tend to be at an earlier stage of development which increases their growth potential. For example, it’s easier for a company making $50 million in profit to double that amount than one that is making $500 million. Similarly, faster growing companies can be harder to find among larger businesses as many already operate in more mature industries.
Greater alignment of investor interest
Smaller businesses tend to have a higher level of founder and/or management ownership, meaning management’s interests are more likely to be better aligned with those of investors.
Greater investment choice
The number of listed smaller companies is greater than those with larger market capitalisation. This provides more stocks in which to invest and therefore, the potential for greater portfolio diversification while offering exposure to companies outside the S&P/ASX 100 index that may be less affected by macroeconomic factors.
More opportunity to generate superior returns
The top 10 small-cap stocks make up around 15% of the small-cap index, compared with the 10 largest large-cap stocks making up around 50% of the S&P/ASX 100 index. This diversity is one reason why active investment managers may have more opportunity to generate superior returns.

“If you are looking for broad diversification across industries and companies, it is best to look outside the S&P/ASX 100 Index.”

Stephen Evans
Senior Investment Analyst