The Big Advantage of Small-Cap Stocks for the Australian Stock Picker

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If you’re a regular reader of the AFR, you may have seen an article on stock picking earlier this week. Or rather, an article on a specific stock picker.

Here is the headline for you:

‘The stockpicker returning 52.6pc’

As that title suggests, it was a short profile piece. Talking to, and about, Thomas Rice and his Perpetual Global Innovation Share Fund.

And, more importantly, Rice’s 52.6% return for the year to 30 September. A result that the AFR dubbed as ‘electrifying returns’.

I couldn’t help but laugh to myself when I read that.

I realise this sounds cocky, but a 52.6% return doesn’t really seem that impressive to me. Not when Rice has a penchant for US tech stocks anyway. He even credits Zoom and Apple as two of his biggest winners.

But, you don’t exactly need to be a stock picker to invest in big tech companies…

There is a reason that they dominate the US markets. Not to mention the fact that they would have delivered a better return than Rice’s.

Year to date, an investor would have made a 71.26% return by simply parking an equal amount of capital in the FAANG stocks. A figure that makes Rice’s 52.6% return seem a whole lot more lacklustre in my eyes.

But that probably just says more about the concentration of the US markets more than anything.

Different strokes for different folks

Now don’t get me wrong, I think Rice has done fine. At least, fine by a fund manager standard.

And a lot of what he talked about in the AFR article is worth listening to. Take this quip, for example:

Everything that actually matters in investing is in the future,

Any stock is going to be based on its future cash flows. It’s not observable. It’s entirely theoretical. So it’s all about coming up with theories about how businesses develop, what creates a competitive advantage and why it’s not competed away.

I completely agree with Rice’s assessment here. Especially now that we seem to have entered a weird new era of permanently low interest rates. Not to mention other, more experimental, central banking policies…

Evaluating a stock today, more than ever before, is all about its potential. Trying to figure out just how much growth it could capture.

However, to then go on to talk about companies like Zoom, Apple, and Disney in the same breath is just a total disconnect for me.

Yes, they are all still growing, albeit with some caveats. But it is pretty damn hard to look at the state of the NASDAQ and label it as sustainable.

A lot of the growth we’re seeing there isn’t necessarily in cash flows, but asset prices. At least at the top end of the market.

Which is why — if you’re looking to make some serious gains as a stock picker — I suggest small-caps. Doubly so for Australian shareholders…

Go small, go hard

See, you might have heard how stock picking is a mug’s game.

Or that it’s a pursuit for those that are destined to become classified as ‘dumb money’.

After all, history has shown that active investing rarely beats passive investing — right?

That is absolutely true. Most active fund managers do indeed fail to beat the broader market index. Which is no doubt why Rice even managed to get his face in the AFR at all.

But, as I explained yesterday, the tide is turning. We’ve entered a stock picker’s market for the first time in over a decade. Read all about that, right here.

Even with that said though, Aussie small-cap stocks have been the saving grace for many fund managers. At least, in the long run.

Just look at this chart:

Port Phillip Publishing

Source: LiveWire & eVestment

[Click to open in a new window]

The green line (Australian Small-Caps), as you can see, has been a standout for fund managers. Not only keeping pace in the shorter time frames, but drastically outperforming in the long term.

And remember, this is for small-caps that fund managers can invest in!

The real advantage for you — as an individual investor — is that most Aussie small-caps are out of reach for funds. They’re just too small and too illiquid for them to invest in.

For this reason, they’re often ignored; by fund managers, by investment banks, by analysts, and by the media…

All of this ignorance leads to a market that is extremely volatile.

Unlike large- and mid-cap stocks, it is a market that isn’t run on tight efficiency.

You can find stock bargains. Or you can find the next big household name. Hell, you can even find bleeding-edge stocks that most people have never even heard of…

My point is, small-caps are the ideal hunting ground for stock pickers. Of course, they come with added volatility and risk, but it’s a market that is perfectly fit for those willing to put in the time and effort to identify companies with future potential.

And more importantly, it is a market that can deliver the biggest possible gains, when you get it right.

But, you’ll have to wait ‘til next week for more info on that…


Ryan Clarkson-Ledward Signature

Ryan Clarkson-Ledward,
Editor, Money Morning

PS: Four Well-Positioned Small-Cap Stocks — These innovative Aussie companies are well placed to capitalise on post-lockdown megatrends. Click here to learn more.

About Ryan Clarkson-Ledward

Ryan Clarkson-Ledward is an Editor at Money Morning.

Ryan holds degrees in both communication and international business. He helps bring Money Morning readers the latest market updates, both locally and abroad. Ryan tackles all the issues investors need to know about that the mainstream media neglects.

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