Honing in on ASX Small-Caps: Three Crucial Questions and One Example

By ,

So, you want to invest in ASX-listed small-caps…

But don’t know where to start?

There are around 2,000 out there.

Today, I’m going to run you through three crucial questions that you should ask yourself about any small-cap investment.

Discover ‘The Explosive Potential of Australian Penny Stocks’. Click here to learn more.

Think of it as a first cut — the building blocks with which you can start to think about investing in the small-cap space.

I’ll give them to you now, so you can have a think about them as we move along.

They are:

  1. Is it a good idea? I know it sounds vague, but this is really important and the hardest one to get a firm grip on.
  2. Is the company growing revenue, in the right way? And…
  3. Do they have the cash needed to fund their growth?

Now for some technical stuff about what’s going on in the small-cap space right now.

Why even bother doing research when you can just ride the wave?

My colleague Ryan Dinse recently did a great piece on where he thinks ASX-listed small-caps will go next year.

His thesis is that there is a divergence opening up in the US small-cap space AND the Aussie small-cap space as well.

Basically, Aussie small-caps have lagged their bigger peers.

Let me show you the chart that ties his thesis together:

Money Morning - Investing in ASX Small Caps

Source: tradingview.com

[Click to open in a new window]

This is the XJO (ASX 200, blue line) matched up against the XSO (ASX top 300 excluding top 100, red line).

Below you can find the correlation coefficient between the two over the last 12 months.

As you can see, at time of writing, XJO has returned a whopping 21.09% over this period and XSO has only returned 13.53%.

All those people piling into the big stocks via index funds would be laughing, for now.

Why even bother doing research when you can just ride the wave?

And as you can also see, the two are strongly correlated until about mid-October, then just before November, a pretty strong drop off in correlation.

What’s going on here?

Cast your mind back to early November.

Well, the wild and wacky RBA actually took a step back from peak weirdness and kept rates on hold.

Maybe all this crowing about the economy going belly up got a bit much for them.

It’s a bit like the trade war nausea — it’s fine! No, the sky is falling! Now it’s fine again! Rinse and repeat.

Anyway, the point I am trying to make is that this divergence between XJO and the XSO could be the beginning of a great opportunity in the ASX small-cap space.

Ignore the headlines and see what the market is doing.

And the market seems to be telling us that small-caps could have more room to run as we change to negative rates.

The three questions revisited

So if there is an opportunity there, how do you go about seizing it?

Remember question one. You can reword it like this — is the company pushing a product or service that is on trend?

If it’s a good idea, it should pass this ‘smell test’.

Let’s see how this plays out with a specific example.

One company that caught my eye recently was Vault Intelligence Ltd [ASX:VLT].

It’s up nearly 60% in the last 12 months.

It passed the smell test — they do workplace safety wearables and fleet safety software (particularly useful in logistics).

I worked in a logistics role for two years and when I had a look at their products, they struck me as innovative, something I wish I had in the field years ago.

So that’s one question down.

Next up, is it growing revenue in the right way?

That is, is it delivering quarter-on-quarter growth in a (relatively) steady way?

The answer is yes, as you can see below:

Money Morning

Source: newswire

[Click to open in a new window]

Finally, do they have the money needed to fund their growth?

This is very important in the small-cap space as capital raises can be frequent and often come at a discount.

It’s all about timing your entry.

In the quarter before these figures were released, they had just $2.78 million on hand, and if you look at their burn rate, you could pretty easily figure out that a capital raise was around the corner.

They ended up going for a capital raise around two months later, right on cue.

So there you have it — a quick introduction to small-cap land and a chart that shows you why you should be paying attention to this space.

Happy hunting,

Lachlann Tierney,
For Money Morning

PS: If you enjoyed this piece and want to make smarter small-cap investments, be sure to look into what an Exponential Stock Investor or Billion Dollar Breakout Trader subscription can do for you. If you are serious about small-cap investing, we think this is the best service on the market. Exponential Stock Investor has a recent focus on the crumbling banking empire, and Billion Dollar Breakout Trader is a unique trading service that aims to beat the smart money.

About Lachlann Tierney

Lachlann Tierney is an Analyst for Money Morning and has been investing for nearly a decade. With a Masters of Science from the London School of Economics, he brings a sound understanding of global markets to his writing. Lachlann is interested in emerging technologies, energy solutions and helping people invest…

Bubs Announces $68 Million Capital Raise

[ASX:BUB] is rattling the can to raise $68 million to support ‘growth opportunities.’

Is Stock Analysis Worth It? Finding Your Investment Edge

Is stock analysis worth your time? The question boils down to a key academic topic: market efficiency.

Bubs (ASX:BUB) Shares up on US Supply Deal Update

Infant nutrition producer Bubs Australia [ASX:BUB] came out with another supplier update today, signing supply agreements with two more US retailers.

NeuRizer [ASX:NRZ] Shares Soar on $1.5 Billion Binding Offtake

NeuRizer [ASX:NRZ] opened 35% higher on Monday after announcing a binding $1.5 billion offtake agreement with Daelim.

Electric Car Demand Is in Overdrive

With the way things are shaping up between automakers, EVs are quickly becoming a hot commodity. And I’m not just talking about Tesla here.

[WATCH] Closing Bell — In the Eye of the Storm

It’s a sea of bad news out there at the moment. Equities have cracked and they are continuing to drift lower.