At the turn of a new calendar year many investors and talking heads in the business media like to consider what might be the best stocks to own for market-thumping returns in the years ahead. In particular the small-cap or ‘casino’ end of the Australian share market can offer huge returns, but comes with a fair bit of risk as investors are often reliant on management forecasts rather than ‘runs on the board’ for example. However, small-cap investing doesn’t have to be like a trip to the casino if you know what you’re doing, or at least if you follow…
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At the turn of a new calendar year many investors and talking heads in the business media like to consider what might be the best stocks to own for market-thumping returns in the years ahead.
In particular the small-cap or ‘casino’ end of the Australian share market can offer huge returns, but comes with a fair bit of risk as investors are often reliant on management forecasts rather than ‘runs on the board’ for example.
However, small-cap investing doesn’t have to be like a trip to the casino if you know what you’re doing, or at least if you follow some common sense rules to avoid obviously dud investments.
For starters you should absolutely avoid companies with little to no revenue or profit.
Over 2018 too many gullible investors were attracted to the pot stock or no-revenue tech sector for example only to see their punts on the likes of Yojee Ltd (ASX: YOJ) Auscann Group (ASX: AC8) or Cann Group Holdings (ASX: CAN) lose 85%, 50% and 40% of their value respectively since this time last year.
I expect further share price falls ahead as these ‘story’ companies still have almost no revenue.
Investing is not rocket science, so if we follow the basic rules of only looking for companies with revenues of at least $50 million and profitability or a visible pathway to profitably that means we don’t have to place too much reliance on management’s forecasts. Additionally that’ll mean we’re starting to take a more professional approach to small-cap investing.
However, there’s no return without risk and the big advantage smaller companies have over large-caps is the law of large numbers means it’s much easier for small companies to double or quadruple profits in a year or two, while a traditional blue-chip share may only grow profit in the mid-single-digits over the long term.
Below are 5 small-cap businesses I expect could perform well in 2019 and beyond.
Accent Group Ltd (ASX: AX1) is the footwear retailer behind the Athlete’s Foot, Platypus and HypeDC shoe stores and has exclusive rights to the distribution of numerous popular brands including tradies’ boots Cat for example. The stock looks cheap at $1.23 with a big dividend yield and this is a well run retailer with an excellent track record of profit growth set to continue in FY 2019.
Australian Ethical Investment Ltd (ASX: AEF) is a fund manager I’ve regularly covered and recommended to small-cap investors over a past four year period over which the stock has climbed around 400% plus dividends. Its profitable and with a market cap of just $180 million and strong FUM flows could easily double again in value over time. For example it has the opportunity to grow in the institutional space if it chooses and fund managers have good operating leverage.
MNF Group Ltd (ASX: MNF) is a business I’m a little reluctant to place on the list as it faces some short-term problems with its investment in a Pennytel mobile virtual network in regional Australia. However, if we assume this is a short-term blight then we’re compensated by the high quality of its core business and a recently discounted share price, with the stock at $4.
Nearmap Ltd (ASX: NEA) is a business I’ve covered a lot previously and it perhaps still has the most raw growth potential. The aerial mapping business is scalable, boasts high gross margins, recurring revenues (albeit with churn a little high) and a large addressable market in the US that it is making credible inroads into. For ‘multi-bagger’ potential it ticks the boxes despite the strong performance in 2018.
Webjet Limited (ASX: WEB) is a borderline small cap given its $1.5 billion valuation, but the online travel agent and business to business (B2B) hotel bookings business has an excellent track record of growth and seemingly strong management team. The stock got trounced in the final quarter of 2018 which gives investors the chance to buy shares today some 40% cheaper than they were just a few months ago.
Tom Richardson owns shares of Accent Group, MNF Group Limited, Nearmap Ltd., and Webjet Ltd.
You can find Tom on Twitter @tommyr345
The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Australian Ethical Investment Ltd. The Motley Fool Australia owns shares of and has recommended MNF Group Limited and Nearmap Ltd. The Motley Fool Australia has recommended Accent Group and Webjet Ltd. 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 Scott Phillips.