2 small-cap ASX shares with an edge over rivals

An expert picks a pair of smaller businesses that are doing all the right things to grow into a larger company.

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Up until earlier this month, the S&P/ASX Small Ordinaries (ASX: XSO) had gained 30% in 12 months.

That amazing run has moderated somewhat after the market dip in the past week but you would still gladly take a 24.6% gain any year of your life.

And, of course, we’re always reminded that all the successful S&P/ASX 100 [XTO] (INDEXASX: XTO) companies were once small caps. Over time, they grew into their now-mammoth valuations.

But there is inherently more risk in backing smaller businesses. Much can go wrong, as much as it can go right.

So it’s interesting to hear when experts pick out some small-cap ASX shares that they think will grow into the next darlings.

It’s all about scale for small caps

Australian Ethical head of domestic equities Mike Murray told a Livewire video that in the small-cap world, the key is to find companies that will scale well.

“It’s just the nature of the beast that some of those industries scale better than others,” he said.

“We tend to find that product-style businesses with that degree of intellectual property are quite scalable, particularly if they’ve got a global market.”

One company he currently likes, Mach7 Technologies Ltd (ASX: M7T), is at “the intersection of healthcare and technology”.

According to Murray, it operates in a similar area to the far-larger Pro Medicus Limited (ASX: PME).

“Mach7 really grew out of a company that specialised in archiving the images that come out of radiology practices in hospitals,” he said.

“And increasingly it’s moved into actually the software around the viewing of those images, which is where Pro Medicus operates.”

Since the transition, Mach7 has won a few “very big” contracts, according to Murray.

“They’re generating a nice rate of growth and you don’t pay the multiples that you pay for Pro Medicus,” he said.

“So that’s an example of a company where we think we’re not paying over the top and it’s a smaller company, so it’s got quite a long runway of growth ahead of it.”

Health insurance is back

After decades of dropping numbers, the private health insurance industry this year has actually seen a rise in Australians signing up.

That’s why Murray reckons NIB Holdings Limited (ASX: NHF) is not just a “boring” insurance stock.

“It’s actually a very innovative company that has been diversifying out of health insurance,” he said.

“Some of the things they’ve been doing include a joint venture called Honeysuckle Health. It’s really a data science play and it’s really all about developing new programs to help people manage their health better and investing in prevention.”

Prevention of health problems benefits both the customer and the insurer, as it reduces future payouts for expensive treatments.

“It helps our system which has some affordability problems.”

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Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. owns shares of and has recommended MACH7 FPO and Pro Medicus Ltd. The Motley Fool Australia owns shares of and has recommended Pro Medicus Ltd. The Motley Fool Australia has recommended MACH7 FPO and NIB Holdings Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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