Pro Medicus Limited (ASX: PME) shares and Gentrack Group Ltd (ASX: GTK) shares are amongst my top small cap picks on the ASX.
Why buy small cap shares?
Most investors make money in shares when share prices rally or dividends are paid.
Good investors believe dividends should only be paid when the company cannot do anything worthwhile with its money. The biggest dividends usually come from 'ex-growth' blue chip companies like Telstra Corporation Ltd (ASX: TLS).
Indeed, if a company is growing and can invest its cash for a return of 15% each year, why would you want them to pay a dividend to investors? In the bank, that cash would earn 3%. Of course, it's best when you get dividends and share price growth.
Small-cap companies are often perceived to be 'growth' companies with long-term potential. The best kinds of small-cap companies, which I define as being worth around $500 million or less, are those that have a niche product or service. They should generate high returns on invested capital (ROIC) and have little debt.
But the best thing about small cap shares is the fact that fewer professional analysts research them. And if fewer analysts follow them it means that the big investment funds have not yet bought in.
Pro Medicus
Pro Medicus fits the bill of a great small cap company, except that its share price has rallied so fast that the Melbourne-based company is now worth more than $530 million. Pro Medicus owns a software that enables doctors to inspect medical images from their phones.
These images are often enormous files, so the fact that Pro Medicus' systems can securely send and receive them in less than a handful of seconds makes it an easy sell to customers, who include some of the biggest hospitals around the world.
Gentrack
Gentrack also creates software. Clients of the $400 million business include airport operators, as well as energy and water utilities. The company recently boosted its UK exposure with the acquisition of Junifer Systems, a water utility software specialist.
While I'm disappointed I missed the rise of Gentrack shares, it is a good business with growth potential. It also pays a handy dividend.
Foolish Takeaway
There are risks to investing in any business, and these small cap companies are no exception. However, if you are buying quality small companies, these are no riskier than any other company on the market, even those in the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO).
