I believe small-cap stocks are among the most exciting investments to own due to their potential for future growth. Yes, investing in smaller companies generally comes with increased risk, and won't be for everyone, but a few carefully selected stocks from the small end of town can make a substantial difference to your wealth-building goals.
Everyone knows of the phenomenal growth stories behind global large-cap shares like Microsoft, Alphabet (Google, YouTube), and Amazon. Those US tech businesses have delivered enormous returns over the last 20 years. However, due to their size today, their earnings growth is arguably now likely to be comparatively slower than what has been delivered to date.
I believe some of the best returns may be found among the next generation of rising businesses, which are smaller and still have significant future growth potential.
I'm optimistic about what could happen in the next five years for quality small-cap stocks. But which small companies are the right ones to invest in? You could work full-time hours trying to analyse all the small businesses out there to invest in. And chances are, you would still make many incorrect choices.
It could be easier (and wiser!) to just invest in a great ASX exchange-traded fund (ETF) to help gain that exposure. The VanEck MSCI International Small Cos Quality ETF (ASX: QSML) could be a top pick for a few reasons.
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Great companies with diversification
Investing in the QSML ETF means getting exposure to 150 of the world's highest-quality small companies.
These companies are chosen from a range of sectors and economies, but all the holdings have a high return on equity (ROE), earnings stability, and low financial leverage.
Having a high ROE means the companies make substantial profits for the amount of shareholder money retained within the business, which suggests that future retained profits could earn a high return as well.
Earnings stability suggests they're not cyclical stocks and can deliver consistent growth of their underlying value throughout various economic conditions.
Low financial leverage (or debt) is a good sign because a small-cap stock's balance sheet strength can be essential for funding growth and ensuring stability during downturns.
This ASX ETF's investment strategy appears to be working. Since the QSML ETF began in March 2021, it has returned an average of 13.2%. The index the fund tracks — the MSCI World ex Australia Small Cap Quality 150 Index — has returned an average of 15.2% per annum over the past decade (which is before fees).
This small-cap stock ETF has an annual management fee of 0.59%. That's not bad, in my opinion, considering the amount of work involved in constructing the portfolio, but it's not exactly cheap either.
However, I really like this ASX ETF as an idea to gain diversified exposure to smaller, faster-growing companies.
