Are small cap stocks going to come roaring back this financial year after lagging their large cap counterparts for most of FY17?
There’s certainly an argument to be made about this with the S&P/ASX Small Ordinaries (Index:^AXSO) (ASX:XSO) generating a paltry return of 0.8% over the past 12-months compared with the 9.7% the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) managed to deliver.
But it’s not the big underperformance of junior stocks that should give you confidence about the passing of the baton from large to smalls per se, it’s the valuation gap that is becoming too hard to ignore.
According to Credit Suisse, consensus data indicates that the one-year forward median price-earnings (P/E) multiple for small caps stands at 14.9 times versus the median P/E of big caps at 17.7 times. This represents a discount of 16% between the two groups, or four percentage points above the long-term average.
Small cap stocks are starting to look more attractive than their bigger rivals and that could see these market minnows outperform in FY18 even though small companies are more vulnerable to any weakness in the domestic economy.
This doesn’t mean you should indiscriminately target stocks in the Small Ordinaries Index though and the good news is that Credit Suisse has come up with a pretty long list of small gems you should consider buying. The stocks are:
- Capitol Health Ltd (ASX: CAJ): The diagnostic imaging group is focused in cost savings and retaining radiologists in the group under new a management.
- Eclipx Group Ltd (ASX: ECX): The fleet management and asset backed financing company posted a strong first half result and reiterated its full year guidance, but the stock is down around 20% off its peak.
- HT&E Ltd (ASX: HT1): The company, which used to be called APN News & Media, is trading at a compelling valuation of around 12 times P/E for FY17, according to Credit Suisse.
- Huon Aquaculture Group Ltd (ASX: HUO): The vertically integrated salmon producer is expected to deliver very strong earnings per share (EPS) growth over the next three years and is leveraged to robust domestic wholesale prices for salmon.
- Inghams Group Ltd (ASX: ING): Credit Suisse thinks there’s earnings upside in the short-term with the poultry company well placed to deliver profit growth beyond FY17.
- Integral Diagnostics Ltd (ASX: IDX): This is another diagnostic imaging company and the stock is just trading on a 13 times P/E for FY18 based on the broker’s estimates. Credit Suisse also thinks the sector is due for a re-rating and that will help propel the stock higher.
- iSelect Ltd (ASX: ISU): The online comparison website operator is trading on undemanding valuations and its revenue growth remains strong with iSelect pursuing new vertical opportunities in large markets.
- Nextdc Ltd (ASX: NXT): The data centre operator is trading at a discount to its larger rivals but this gap is likely to close in the not too distant future.
- Speedcast International Ltd (ASX: SDA): The satellite services provider has doubled in size since its acquisition of CapRock, which appears to be an astute buy at the bottom of the cycle for the industry. The broker is tipping double digit EPS growth till FY20 at least.
- Steadfast Group Ltd (ASX: SDF): The insurance broker’s valuation is looking full but it has sufficient financing in place to fund growth and could deliver significant profit growth in FY19 and FY20, said Credit Suisse.
- Southern Cross Media Group Ltd (ASX: SXL): The share price of the broadcast group is not factoring in favourable changes to media ownership laws and is trading on inexpensive valuations.
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Motley Fool contributor Brendon Lau has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. 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.