4 stocks we favour as large caps shrink and small caps shine

Cost cutting has worked in the post-Covid era but to drive growth companies must reinvest and innovate.
Chris Prunty

QVG Capital

Reporting season has underlined a problem Aussie investors have long suspected: there is very little growth left on the ASX. Downgrades outnumbered upgrades, as they tend to do, but this was the third year with no aggregate absolute earnings growth. Margin pressure was a recurring theme. And the large-cap names that investors once looked to for stability proved themselves every bit as volatile as their smaller peers.

Banks are leaning on cost-out programs and buybacks rather than top-line growth. Miners are dependent on China’s stimulus cycle. Consumer names were a rare bright spot as households opened their wallets in July and August. 

In tech, a couple of the largest names have put themselves in the sin-bin for now. Wisetech’s (ASX: WTC) organic growth slowdown has unnerved investors who once treated it as a structural play on global trade. Xero (ASX: XRO) is under pressure after a large US acquisition at a silly price that raised questions about discipline and governance. Both stocks have been marked down heavily.

Proving it’s better to be lucky than good-looking, this growth scarcity and de-rating of a couple of the large cap growth darlings has played into the hands of smaller company investors. Several small caps produced double-digit revenue growth in FY25, often with reinvestment opportunities that give confidence in the runway ahead. In a market where earnings growth is rare, that combination commands a premium. 

Small caps have begun to outperform not because conditions are easy, but because they remain one of the few places growth is available.

Cost cutting will only get you so far

The macro picture explains much of this. Australia’s economy has relied for decades on a mix of commodity exports and population growth. That has masked a deeper issue: flat productivity. Output per worker has barely improved. Unit labour costs are rising. Taxes and regulation weigh heavily on business formation and reinvestment. Reporting season made plain that this backdrop now matters. Companies, in aggregate, have done a great job since Covid of masking weak growth with cost out but this is not a bottomless well.

Cost discipline has its place, but it is no substitute for innovation. Too many boards have responded to under-investment in prior years with cost out programmes. These actions have the benefit of boosting short-term earnings without building competitive advantages, new products or opening new markets.

Four stocks we favour against a low-growth backdrop

We favour businesses that can grow despite Australia’s low-growth settings. Offshore expansion is one avenue: Lovisa (ASX: LOV) is an excellent example of this. Enterprise software businesses such as Hansen Technologies (ASX: HSN) or Catapult Sports (ASX: CAT)  also have global appeal. Domestically, there are still operators such as Generation Development (ASX: GDG) who can reinvest earnings into product, distribution or technology and generate compounding returns.

The large-cap end of the market offers little genuine growth. A couple of the larger growth juggernauts are out of favour. The growth dollar must go somewhere. This is a great set up for the handful of smaller companies that have the potential to grow their earnings for many years to come.

Join our webinar on September 17 for detailed insights on reporting season, our market outlook, and key opportunities at QVG Capital. Register here. 


6 stocks mentioned

Chris Prunty
Principal & Portfolio Manager
QVG Capital

Chris Prunty is a co-founder and Portfolio Manager at QVG Capital; a boutique investment management firm specialising in smaller companies. QVG manages money on behalf of high net worth individuals and institutions in a 'best ideas' portfolio of...

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