These are the 2 best small cap ASX shares to buy right now: fund manager

Investors shouldn’t buy stories, they should buy fundamentals.

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Matthew Booker, portfolio manager and co-founder of Spheria Asset Management

Image source: Spheria Asset Management

Ask a Fund Manager

The Motley Fool chats with fund managers so that you can get an insight into how the professionals think. In this edition, Matthew Booker, portfolio manager and co-founder of Spheria Asset Management, shares 2 small cap ASX shares to buy right now.

Motley Fool: How would you describe your fund to a potential client?

Matthew Booker: The Spheria Australian Smaller Companies Fund provides clients with a sensible way to gain exposure to the significant growth upside that small companies can provide relative to large companies. It aims to outperform the S&P/ASX Small Ordinaries Accumulation Index over the medium to long term.

MF: Small cap ASX shares can come with more risk. What types of risk management do you employ?

MB: Our bottom-up investment process has a strong emphasis on risk management and works to identify robust businesses which have solid and predictable free cash flow generation and, very importantly, where there is valuation support.

We naturally avoid parts of the market trading on nonsensical valuations and those aspirational concept stocks that often lead to capital losses.

MF: What are the advantages of investing in small cap ASX shares?

MB: It’s well known that the small cap sector can provide strong returns. If you look at the journey of a listed company, it is often the time as a microcap or small cap where investors are exposed to the greatest growth in its life cycle, and therefore the greatest gains are to be had.

Many smaller companies have very little analyst coverage or are not covered well. This is an advantage for professional investment teams like Spheria, who are dedicated to fundamental research and have systems and processes designed for this environment.

When our investment process identifies a likely winner, more often than not, the broader market is yet to realise the potential. In many cases, we’re investing against the trend. In our experience, most money tends to be made when taking a view contrary to conventional wisdom.

MF: Is the lack of analyst coverage in the smaller end of the market an issue for you?

MB: We’re very numbers-driven and know the financial statements for our companies inside and out. And we have great access to management that allows us to overlay a view on their capabilities. It’s nearly impossible to get this type of management access in the large cap space.

Also, the impact of large cap managers tends to be less pronounced given the size of the companies they’re running. For example, a great manager of a small cap ASX share is always going to have more shareholder impact than a new CEO running, say, Telstra Corp Ltd (ASX: TLS).

MF: You mentioned your risk management protocols earlier. What’s the biggest risk for investors buying smaller ASX shares?

MB: The biggest risk is getting caught up in the exuberance that often makes its way into the small cap universe. There are many businesses that trade on high multiples simply because they tell a good story. But investors shouldn’t buy stories, they should buy fundamentals.

Buying narratives is a great way to see your capital evaporate in the small cap sector, in the long run.

MF: What are the two best small cap ASX shares to buy right now? 

MB: InvoCare Ltd (ASX: IVC) and Blackmores Ltd (ASX: BKL).

MF: Why do you like Blackmores?

MB: Blackmores is on the cusp of a return to greatness. We were ecstatic that the market sold it off after the last result as we believe the company has never been in better shape. Growth is exploding in its key markets in Asia, with Thailand and Indonesia growing at sales of 50% plus from a large base with overall group sales growing 15% in the half-year.

More than half the group’s sales now come from the Asia region, which is massively underpenetrated.

We also believe there’s a huge shift underway to natural therapies and supplements with awareness of the role these can play in improving general health and, more specifically, boosting the immune system. The Blackmore’s brand and reputation will see it harness this extraordinary growth in its key markets, which will invariably find its way to significant profit growth for the company in the short and long term.

MF: And why is InvoCare a top buy for your fund?

MB: InvoCare is the largest funeral and memorial services operator across Australia, New Zealand, and Singapore. The company is most of its way through a significant refurbishment program that will enable it to sustain or even increase market share.

Counterintuitively, excess deaths in Australia, relative to the average, have trended negatively for the last two years despite the pandemic. Unfortunately, as the economy returns to normal, we believe death levels will return to average. But this will benefit industry participants, including IVC.

Trends in excess death rates overseas lend support to this thesis.

MF: Atop recommending they acquire professional advice, what other guidance do you have for investors looking into small cap ASX shares?

MB: You need to swallow the fact that, when investing in the small cap sector, you are going to make mistakes and lose money on positions. You cannot get everything right, and that’s why you have a portfolio and risk controls. The key is recognising when the facts have irrevocably changed for a holding and then moving it on at a loss. This requires a high emotional intellect and experience.

MF: Has Russia’s invasion of Ukraine changed your investment approach? 

MB: No, we don’t get caught up in the latest news and current affairs.

We have companies that are benefiting from higher commodity prices due, in part, to the conflict. And we have other ASX shares that are adversely impacted through, for example, higher oil prices raising transport costs.

Whether these are short- or long-term impacts will depend on the duration of the conflict, which no one can accurately predict. We’re confident our portfolio of businesses will ride this out.

The market is constantly throwing up new drama fuelled narratives. The key is to focus on the sustainability of a company’s cash flows through the cycle and its valuation.

***

(You can find out more about the Spheria Australian Smaller Companies Fund here.)

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Scott just revealed what he believes could be the five best ASX stocks for investors to buy right now. These stocks are trading at near dirt-cheap prices and Scott thinks they could be great buys right now.

*Returns as of January 12th 2022

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia owns and has recommended Telstra Corporation Limited. The Motley Fool Australia has recommended Blackmores 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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