I believe that some of the smallest businesses have the strongest potential to deliver impressive returns. In this article I'm going to look at two ASX small-cap shares that look promising.
It's a lot of work for a large business to grow its revenue from $10 billion to $20 billion. A small business may find it easier to increase revenue from $10 million to $20 million.
If a small business can grow so much, it can be good news for the market capitalisation to rise, which is good for shareholder returns. With that in mind, let's look at two ASX small-cap ASX shares that could grow significantly.
Australian Ethical Investment Ltd (ASX: AEF)
The Australian Ethical share price has dropped 20% since 25 September 2023 and it's down 73% from November 2021. It's still the same business as it was in 2021, it just looks a lot cheaper to me.
What is this company? It's a fund manager that aims to provide investors with "investment management products that align with their values and provide competitive returns." It avoids certain sectors like fossil fuels and there are a number of other investment considerations.
The ASX small-cap share offers superannuation, so it can tap into that very strong tailwind of building retirement funds. Mandatory superannuation contributions are helping push up the funds under management (FUM) and the FUM can grow organically from the investment returns.
In FY23 it saw organic net inflows of $0.47 billion. FUM finished FY23 at $9.2 billion, partly thanks to the successor fund transfer with Christian Super. The added Christian Super members could mean that there are more net flows in FY24 onwards.
In FY23, underlying net profit after tax (NPAT) rose 15% to $11.8 million. Fund managers can be very scalable – it won't necessarily take 20% more staff to manage 20% more FUM. As Australian Ethical becomes bigger, I expect its margins to rise.
Investors like to focus on profitability when it comes to valuing a business, so I believe there is good potential here for shareholder returns. It's expecting to grow its revenue by more than 20% in FY24.
Accent Group Ltd (ASX: AX1)
Accent is one of the largest shoe retailers in Australia. It distributes for a number of brands including CAT, Dr Martens, Henleys, Kappa, Skechers, Ugg and Vans, while owning some brands itself including The Athlete's Foot and Glue Store.
I like to look at good businesses when they fall 20%, 30% or even more. If a share price falls 50% from $20 to $10, simply getting back to $20 would mean a return of 100%. However, just because something has fallen doesn't mean it will go back up.
The ASX small-cap share was doing well in its latest trading update, despite all the economic challenges that Aussies are facing amid the elevated inflation and higher interest rates. In the first seven weeks of FY24, sales were up 2.8%. Despite that, the Accent share price is down close to 30% since April 2023.
That sales growth happened even though the business was driving "full price, full margin" sales, suggests its profit margins could hold up well. Digital sales were up more than 20% in the first seven weeks of FY24.
In the longer term, I believe that its growing portfolio of brands, its increasing store count and the scale benefits can lead to stronger profit and good dividends. At least 50 new stores are planned to open in FY24.
According to Commsec estimates, the ASX small-cap share is valued at under 12x FY25's estimated earnings with a projected grossed-up dividend yield in FY25 of 10.7%.
