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Wilsons Advisory says small-cap stocks have outperformed their larger peers since the first Reserve Bank of Australia interest rate cut in February, but they still trade at a significant discount.
The broker has named a number of stocks it sees as good buys in the current market, pointing out that many of these companies are under-researched by brokers and operate in higher-growth sectors of the economy.
Compared to the ASX 100, the Small Ords index is far less concentrated and is less tilted towards growth-challenged sectors such as banks and iron ore. While just the banks and iron ore comprise about 38.5% of the ASX 100, these low growth sectors account for just around 1.5% of the Small Ords. While passive flows into banks (and other blue chips e.g. Wesfarmers) have supported the ASX 100's outperformance prior to this year, we believe this will unwind as valuations remain overstretched, particular considering their meagre growth outlooks.
As a result of being covered by fewer analysts, and traded by fewer investors, there was a higher degree of mispricing among smaller stocks, Wilsons says, and it also argues there are more merger and acquisition targets.
The broker also argues that small-cap stocks benefit disproportionately from rate cuts, as they are more exposed to cyclical sectors such as consumer and retail and carry more debt.
While small caps have outperformed since February as investors acknowledge the earnings boost provided by rate cuts, valuations have yet to overrun and still provide an attractive entry point.
Wilsons favours stock feed and fertiliser company Ridley Corporation Limited (ASX: RIC), saying it was reinvesting to support growth, and had made a highly accretive fertiliser acquisition.
RIC screens attractively at a forward price to earnings of 19x while offering three-year earnings per share compound annual growth rate of 15%. Management has been focusing on acquiring, expanding and de bottlenecking stock feed mills, adding incremental capacity. Increasing its scale also lowers the cost per tonne of feed, improving its unit economics and helping defend margins in a competitive market.
Wilsons also likes medical device infection solutions company Nanosonics Limited (ASX: NAN), saying the core TROPHON business is well-positioned and has an upcoming product launch.
Wilsons is predicting compound annual earnings per share growth of 21% for five years for Nanosonics.
With its recent FDA approval, CORIS, the first device cleared for automated cleaning of flexible endoscopes, is set to launch in FY26 and deliver material earnings upside.
Other companies favoured by Wilsons include Maas Group Holdings Limited (ASX: MGH), GemLife Communities Group (ASX: GLF), and Autosports Group Limited (ASX: ASG).
