Small-cap stocks are often overlooked by investors because finding those with true growth potential can be challenging, which is why properly evaluating their underlying fundamentals is essential, according to a boutique fund manager.
ICE investors managing director Callum Burns highlighted a disciplined approach is necessary when investing in small-cap companies, given the considerable performance gap between higher-quality entities and those that struggle to thrive.
“The small-cap universe can be a significant challenge. There are a lot of opportunities out there, but there are also many pitfalls. This is why a careful, methodical approach to stock selection is extremely important in small-cap investing,” Burns noted.
“There are around 200 companies in the Australian Securities Exchange small-cap index and many more not even in the index, yet many of these companies are not attractive from an investment point of view.”
He added research conducted by his firm had identified a “sweet spot” within the small-cap space, consisting of companies with solid business foundations and strong competitive advantages that are more likely to succeed over time.
Commenting on the findings, he acknowledged these companies tend to be better positioned to endure economic challenges and offer more stable long-term growth prospects, making them a more attractive investment option compared to others in the small-cap space.
“Robust business franchises are characterised by several key features, including having an economic moat around the business that protects revenue from competitors, difficult to replicate assets, such as licences and brands, barriers to entry for new competitors, an entrenched customer base that faces obstacles in switching to competitors, sustainable competitive advantage and pricing power,” he noted.
“There are still many great small-cap companies out there waiting to be discovered. However, investors need to be equipped with the right research and due diligence to differentiate between low-quality small caps, with little potential to outperform, from the next top 100 companies.”
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