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Top Broker picks small cap heroes to buy for the reporting season

Small caps are finally finding favour with investors with the smaller end of the market outperforming their bigger brothers as we head into the February reporting season.

The S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO) index has surged 8.2% since the start of the year when the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) is up 6.8%.

This marks a turnaround from late 2018 when junior stocks suffered a more brutal sell-off as shareholders became risk averse.

Small caps back in favour

But sentiment has turned as investors become more confident that the sky wasn’t falling and that a recession isn’t imminent.

The question now is which emerging company to back for this unfolding profit reporting season given that there are still areas of weakness in the economy and the market is in an unforgiving mood when it comes to bad earnings news.

Morgan Stanley attempts to answer this question by highlighting small cap stocks where it has a high level of confidence that they can deliver this month.

Conviction picks

There are two names that stand out for growth, in the broker’s opinion. This is student services group Idp Education Ltd (ASX: IEL) and mapping services company Nearmap Ltd (ASX: NEA).

“IEL’s ~20% top line growth is more durable than the market expects, driven by multi-destination and the shift to computer based IELTs testing,” said Morgan Stanley.

“We see FX tailwinds, potential for upside product expansion – e.g., Hotcourses and, and ~50/50 1H/2H split as putting IEL on track to deliver a strong result despite high expectations.”

As for Nearmap, the broker believes its strong annualised contract value (ACV) and sales momentum in the first half of FY19 will carry through, especially given that Nearmap’s earnings are skewed to the second half.

Morgan Stanley lifted its price target on IDP to $11.80 from $11 per share and increased its target on Nearmap to $2.25 from $2 a share.

Meanwhile, the broker said that those looking for value can opt for childcare operator G8 Education Ltd (ASX: GEM), infant products retailer Baby Bunting Group Ltd (ASX: BBN), telecom services group MNF Group Ltd (ASX: MNF) and novated leasing and vehicle services provider McMillan Shakespeare Limited (ASX: MMS).

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Motley Fool contributor Brendon Lau owns shares of Baby Bunting. The Motley Fool Australia owns shares of and has recommended MNF Group Limited and Nearmap 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.