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ASX small cap stocks to avoid ahead of the August reporting season

If you are feeling nervous about traversing next month’s company reporting season, you should be!

Experts are anticipating a wild ride as stretched market valuations stand in contrast to a lacklustre earnings environment and uncertain macroeconomic conditions.

What’s interesting is that the S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO) index has played catch-up to the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) since the start of this calendar year although it’s still lagging on a 12-month basis with a gain of around 2.4% compared with a 6.6% increase by the 200 biggest stocks.

There are reasons to feel upbeat about small caps but don’t be fooled into thinking there are fewer earnings flops at the smaller end of the market.

If you are wondering where the ASX small cap profit landmines are, Morgan Stanley has pinpointed five you should avoid for next month.

Reject Shop Ltd (ASX: TRS): A tough trading environment, change in management and balance sheet risks completes a trifactor of reasons to keep a wide berth of the discount variety retailer. Talk about rejects!

Webjet Limited (ASX: WEB): Morgan Stanley believes earnings will meet market expectations but the online travel website operator could spoil the party by taking a more cautious approach to FY20 outlook (FY20 consensus earnings forecasts range between $167 million and $189 million) and a further step up in capital expenditure.

Premier Investments Limited (ASX: PMV): Brexit isn’t helping the apparel and stationary retailer. The broker sees scope for further UK macro softness to impact on the group’s Smiggle business, which would be a major headwind for the stock.

SG Fleet Group Ltd (ASX: SGF): The SGF share price may have run ahead of fundamentals. Morgan Stanley believes the recovery in sentiment towards the novated leasing group and the re-rating in the stock since April may have moved its share price ahead of earnings, particularly with compressing yields and strategic initiatives that could be a short-term headwind.

Smartgroup Corporation Ltd (ASX: SIQ): The rival to SG Fleet suffers from similar issues. The broker believes that growth expectations may be set too high and that volumes could disappoint and yields could be further compressed.

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Motley Fool contributor Brendon Lau owns shares of Premier Investments Limited. Connect with him on Twitter @brenlau.

The Motley Fool Australia owns shares of and has recommended Premier Investments Limited. The Motley Fool Australia has recommended 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.