I’ve noticed recently that a number of fund managers and analysts have said that it’s a ‘stock pickers market’ where individual stock selection is important. In other words, investors can’t just pick the shares that have performed the best in the past few years and expect performance to continue. A perfect example of that is the big four banks.

What I have noticed is that after underperforming the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) over the past five years, the S&P/ASX Small Ordinaries (Index: ^AXSO) (ASX: XSO) has been making a comeback over the past six months.

Small Ords vs ASX 200

Source: Yahoo Finance

 

That suggests that while the companies that dominate the ASX are struggling for growth, smaller companies are outperforming – and that suggests it is there where investors should be looking for companies that can beat the market.

The Small Ordinaries index represents the small cap members of the S&P/ASX 300 index but excludes those that are in the ASX 100.

If investors don’t want to pick the shares themselves, they can always invest in exchange traded funds that track the performance of the index, including the iShares Small Ordinaries Index Fund (ASX: ISO) or the SPDR S&P/ASX Small Ordinaries Fund (ASX: SSO).

However, the Small Ords also includes what I would call non-investment grade companies, including a number of miners and energy companies. With their outlook dependent on commodity prices, investors may want to consider ‘stock picking’ and selecting from a number of quality industrial companies.

These companies include the following eleven…

Company Name Last price Market Cap
iSentia Group Ltd (ASX: ISD) $3.47 $694m
NIB Holdings Limited (ASX: NHF) $3.91 $1,717m
Premier Investments Limited (ASX: PMV) $14.98 $2,347m
APN Outdoor Group Ltd (ASX: APO) $6.13 $1,021m
ARB Corporation Limited (ASX: ARB) $14.63 $1,158m
RCG Corporation Limited (ASX: RCG) $1.58 $793m
Virtus Health Ltd (ASX: VRT) $6.13 $490m
Bellamy’s Australia Ltd (ASX: BAL) $10.64 $1,028m
IPH Ltd (ASX: IPH) $6.95 $1,295m
Retail Food Group Limited (ASX: RFG) $5.56 $914m
Altium Limited (ASX: ALU) $5.61 $731m

Source: Google Finance

As you can see, these aren’t what many would consider as ‘small’ companies, but they could all definitely grow up to be much bigger. That’s one of the advantages these companies have over their larger counterparts – in many cases, they have more opportunities for growth.

While a number of the companies in the table above may appear nose-bleeding expensive on a P/E ratio basis, it’s important to remember that if the companies are growing strongly, those P/E ratios can come down very quickly indeed.

Foolish takeaway

There’s one other bonus for investors investing in smaller companies and that’s the fact that they are generally under-researched and out of the mainstream media spotlight. That means more chance that the market will misprice the shares – an advantage for Foolish investors to make the most of.

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Motley Fool contributor Mike King owns shares of Altium, Bellamy's Australia, and iSentia Group Ltd. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia owns shares of Altium, Bellamy's Australia, and Retail Food Group Limited. 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. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.