Aside from CSL Ltd (ASX: CSL) and a handful of other companies, it'd be hard to argue that Australia's blue-chip stocks provide decent growth prospects over the medium term.
Although they may not be considered 'blue chip' by some, I think stocks like XERO FPO NZ (ASX: XRO), Flight Centre Travel Group Ltd (ASX: FLT) and ResMed Inc. (CHESS) (ASX: RMD) are smaller growth opportunities in the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) worth considering. And in case you're wondering, yes, I own shares in all of them.
Nonetheless, I believe a slowing economy, plunging commodity prices, below-average house price growth and slowing wage price growth will weigh on the profits and share prices of many of the ASX's top blue chip companies for the foreseeable future.
Companies with international exposure, or — at least — local industry tailwinds; competitive advantages and little debt, are currently at the top of my watchlist — combined with my usual stock-picking checklist, of course. Unfortunately, every retail investor and institutional stock analyst worth his or her weight in salt is seeking the same things.
Therefore, in addition to building a watchlist of quality mid-cap stocks, enterprising investors should be prepared to look outside the usual suspects in the ASX 200, towards small-cap stocks. In the small-cap space, which some investors may define as companies with market capitalisations of less than $500 million, fewer analysts roam.
Since many fund managers may be prohibited from buying small-cap stocks, they also tend to be less researched by analysts, and therefore, there's more chance of mispricing. Exploiting the mispricing (the difference between a stock's market price and intrinsic value) can presents compelling opportunities for savvy investors, potentially leading to the outperformance of benchmarks such as the S&P/ASX 300 (Index: ^AXKO) (ASX: XJO).
3 small-cap stocks I'd buy today
With that in mind, here're three small-cap stocks I'd buy today, and likely will (once the Motley Fool's compliance team clears me to trade them):
- Yowie Group Ltd (ASX: YOW) is one of the ASX's best-hidden treats (don't excuse the pun). It produces the famous Yowie chocolates, with a child's play toy inside. Yowie has a competitive advantage waiting to be locked in within the US consumer market because its products are currently being rolled out across great retail lines like Safeway and Walmart with huge success. Moreover, under an exclusive patent license with its manufacturer, Whetstone, Yowie can produce and distribute it products competition free! Indeed, since a toy inside chocolate is a potential choking hazard, a patent for the way the chocolate 'cracks' is able to be exclusively used by Yowie until April 2018, for a fee. By then, Yowie will be an established player in the market and should be able to defend its market share against giants like Ferraro and Kinder. Canaccord Genuity analysts believe Yowie shares (currently $1.11) are worth $1.60. I think they're worth more, so it mightn't shock you to know I bought more shares as recently as last fortnight.
- Somnomed Limited (ASX: SOM) makes devices for the treatment of sleep apnoea, like ResMed and other international heavyweights. However, compared to its rivals' products, Somnomed's SomnoDENT is cheaper, easier to use and can be just as effective. Globally diversified, Somnomed shares afford investors healthy exposure to foreign markets with the defensive and recurring sales revenue that only a quality healthcare business can provide. While Yowie arguably is better valued, Somnomed is a lower-risk option in my opinion.
- Bulletproof Group Ltd (ASX: BPF) provides services to take customer networks and applications from standalone networks to the cloud, using Amazon's AWS and VMware. The business is moderate to highly scalable, but it remains to be seen if its offering affords it a durable competitive advantage. Nevertheless, Bulletproof is one of my larger small-cap stock holdings because it's growing well, thanks in part to industry tailwinds; has managers with significant 'skin in the game', despite the recent capital raising; and I suspect it will significantly widen its profit margins over coming years. Bonus points go to Bulletproof (and its shareholders) for pulling off a retail share purchase plan (SPP) and raising 2.3x the expected take-up. Currently priced at 30 cents, I wouldn't be surprised to see Bulletproof shares hit 50 cents in coming years.
