The stock market can be a great way for investors to build wealth. There are some ASX shares that I think will beat the overall market.
The overall ASX share market return is mostly dictated by the biggest companies such as Commonwealth Bank of Australia (ASX: CBA), BHP Group Ltd (ASX: BHP), CSL Ltd (ASX: CSL), National Australia Bank Ltd (ASX: NAB)), Westpac Banking Corp (ASX: WBC), Wesfarmers Ltd (ASX: WES), ANZ Group Holdings Ltd (ASX: ANZ), Macquarie Group Ltd (ASX: MQG), Goodman Group (ASX: GMG) and Telstra Group Ltd (ASX: TLS).
But, within the stock market, there are some businesses that perform better than others. Technology businesses certainly have their advantages compared to other sectors because of the higher profit margins and the ability for software businesses to rapidly scale, compared to companies that sell physical products.
But, investors are very aware of the long-term growth potential of names like Pro Medicus Ltd (ASX: PME), Xero Ltd (ASX: XRO), REA Group Ltd (ASX: REA), WiseTech Global Ltd (ASX: WTC). These businesses trade on a higher price/earnings (P/E) ratio than other sectors.
I think there's one area of the market that investors have the most potential to outperform the ASX stock market.
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ASX small cap shares
I think certain ASX small-cap shares can deliver stronger returns than the stock market. That's because of a couple of key advantages.
Firstly, they can have a lot more earnings growth potential. Large businesses like REA Group, Xero and Goodman were much smaller a decade ago. Investing in smaller businesses when they're earlier on in their growth journeys means there is significant scope for earnings to grow by multiples before the growth rate starts slowing.
Investors usually value a business based on how much profit it makes, so having a much longer growth runway gives the business more time to scale.
Another point I'll make is share prices reflect market (analyst) expectations. Lots of analysts follow large businesses like CSL, REA Group and Macquarie. It's not very likely, in my opinion, that investors would be unaware of the growth prospects of these businesses, nor are they as likely to become as undervalued as a smaller business, in my view.
ASX small-cap shares aren't as widely followed as their larger counterparts and therefore may be mispriced. So, not only do they have a lot more growth potential, but the market may not realise how much that business could grow in the coming years. Of course, not every small business is destined to deliver big returns, but some may.
Identifying those next big winners is a major part of what Motley Fool's services are all about. In my own portfolio, some of the smaller stocks with big growth potential I own include Tuas Ltd (ASX: TUA), Temple & Webster Group Ltd (ASX: TPW) and Guzman Y Gomez Ltd (ASX: GYG).
