Small caps cop a battering, but quality Aussie stocks remain compelling

While the broader small caps market has notably struggled in Australia’s sluggish, high-interest economy, quality small caps stocks have bucked this trend, delivering significant outperformance for investors, according to a local analyst.

The recent reporting season has, according to Sam Twidale, portfolio manager Australian investment firm DNR Capital, underscored the significant challenges faced by listed companies in the current economy, who have borne the compounding effects of margin reversion, stretched balance sheets, high interest costs and underperforming acquisitions.

As a result, Twidale said, investors have seen “some significant share price reactions to the downside for several companies”.

However, the cream of the small company stocks has risen to the top, providing considerable gains for quality-seeking investors.

For instance, DNR Capital notes, its quality-focused Australian Emerging Companies Fund has delivered significant outperformance against the index.

In the 12 months to the end of August, DNR reports that the Fund has returned 19.74% to investors, notably above the 8.51% of the S&P/ASX Small Ordinaries Total Return Index. Since its inception in mid-2018, the Fund has delivered excess returns of 9.62% above the index.

DNR singled out local household appliance manufacturer Breville, a long-held position in the Fund, as a recent standout performer.

“Breville really showed its strength this season. Despite concerns around consumer resilience in a high interest rate environment, the company’s continued reinvestment into product development and geographic expansion has put it in arguably the strongest position in its history,” Twidale said.

He also noted the strong performance of wealthtech companies HUB24 and Netwealth, which “continue to cement their positions as market leaders, taking significant share from legacy incumbents”.

“Their success is driven by economies of scale, reinvestment in their platforms and superior customer service,” he said.

Despite persistent headwinds, Twidale recognised compelling opportunities small caps space.

“There is a big dispersion in quality across the market and that really came through in reporting season.”

He concluded: “Our focus remains on being highly selective and targeting quality businesses in the consumer, financials and tech sectors where we see the potential for attractive long-term returns.”