7 ASX stocks the market may be undervaluing

Markets have a habit of creating opportunity in the places investors stop looking. Right now, as money floods into large-cap safety, a growing gap is opening between what many ASX small caps are earning and what investors are willing to pay for them.

That’s the paradox sitting at the heart of the current market. The fundamentals are strong but the noise is louder. And somewhere in that gap between what companies are actually earning and what investors are willing to pay, sits what Nick Sladen and Nick Leitl of LSN Capital Partners believe is one of the most compelling valuation opportunities in years.  

Speaking in their latest webinar, Sladen and Leitl argued that the gap between large caps and small caps has quietly stretched to levels that look increasingly hard to justify.

At the same time, the market is undergoing a powerful rotation. Resources and industrial businesses tied to infrastructure and electrification are seeing earnings forecasts surge, while technology stocks have endured a sharp valuation reset.

For those willing to look further than headlines, the result may be a market full of opportunities. In this wire, I outline the key findings from the webinar. 

The number that should make every large-cap investor uncomfortable

The numbers are where the story starts and within LSN’s portfolio, the average company is currently trading on a price-to-earnings multiple below 15x, while forecast earnings growth sits just under 15% over the next 12 months.

Compare that to the ASX 100, sitting closer to 19x PE with mid-single-digit earnings growth. Same market. Same economy. Roughly the same risks. But in LSN’s case, the small-cap companies they own are priced significantly cheaper while growing earnings materially faster.

"The disconnect between large and small caps post the recent selloff has expanded to multi-year attractive levels."

With uncertainty in markets, investors have been spooked into piling into the familiar, larger, liquid names – the big banks, the large miners, the household names. When markets get choppy, money flows to size. It is a rational short-term instinct, but it can create irrational long-term pricing.

The ASX’s four big banks carry commanding index weight and have benefited from a rotation into perceived safety. The result is that quality small-cap businesses – profitable, growing, cash-generative – are being left behind.

LSN’s track record over the last three years has been 15% per annum returns. The portfolio’s own scorecard from this reporting season saw 40% of holdings beat expectations, 35% came in line, and earnings per share for the portfolio were revised up 2-3%. Over 50% of holdings are debt-free. These are not distressed businesses waiting for a rescue. They are compounders being priced as if they are broken.

"Markets tend to follow earnings that are rising rather than falling."

Reducing exposure to resources (including gold) and selectively buying tech after an aggressive sell-off

In markets, what fund managers are selling can often be more revealing than what they are buying. In LSN’s case, that rotation has been quite deliberate.

Over the past few months, they’ve exited all three of their direct gold positions: Ramelius Resources (ASX: RMS), WestGold (ASX: WGX) and Genesis Minerals (ASX: GMD). All three are graduating into the ASX 100, a milestone that coincides with LSN choosing to walk away. 

Their reasoning is straightforward. The sector is well-owned, momentum-driven, and does not offer the defensive attributes investors may expect in a period of geopolitical tension. Gold stocks have declined sharply during the recent conflict, a period when the metal would normally act as a safe haven. That divergence, to Sladen and Leitl, is a warning sign, not a buying signal.

"Momentum in businesses and sectors can run extremely hard both ways."

Additionally, they’ve also trimmed copper exposure, reduced lithium, and cut several other material positions that had “rallied hard from a valuation perspective”. The materials sector is now their largest underweight, roughly 20 percentage points below its benchmark weight in the Small Ordinaries index.

Where is that capital going? Into quality industrials and technology. Specifically, into companies that reported strong earnings upgrades but saw their share prices fall anyway, caught in the broad sector derating that’s now been running for seven consecutive months.

The ASX technology sector is roughly 40% off its highs, which is exactly where LSN are leaning in.

The AI trade that nobody is talking about

When we think about AI exposure on the ASX, it’s easy to think about software businesses; who will survive disruption, who will be displaced, and which SaaS names are at risk. But LSN are thinking about it differently. Their focus is on the infrastructure layer: the physical and data plumbing that AI demands, regardless of which software platforms ultimately win.

The poster child for this thesis is Megaport (ASX: MP1), which provides network connectivity between data centres by moving data between facilities and customers. As AI workloads grow, the amount of data moving between data centres, cloud platforms and end users is increasing rapidly.

"The movement of data and the processing of data with AI is only increasing the demand for data movement."

With AI workloads increasing both the volume and complexity of data traffic, Megaport sits directly in that flow.

LSN has been increasing its exposure to this area following the sharp correction in technology valuations. Their view is that the recent selloff has created opportunities in businesses that still have strong growth prospects.

In other words, they are not chasing the AI hype. They are investing in the infrastructure required to support it.

The industrial capex boom

One area where Sladen and Leitl remain particularly constructive is the industrial capital expenditure cycle.

Across Australia and globally, several structural themes are driving investment.

Electrification is one of the most important. As energy systems transition toward renewable sources, significant spending is required on power transmission infrastructure. Grid upgrades, renewable generation and energy storage are all capital-intensive.

Mining services is another driver. Strong commodity prices have left many mining companies with robust balance sheets and the ability to expand exploration, as well as fund new projects.

"Large mining companies and small mining companies are cashed up."

Infrastructure spending also remains elevated, particularly in regions such as Queensland, where major projects linked to the 2032 Brisbane Olympics are beginning to ramp up. Companies exposed to these themes have already begun to see strong earnings growth.

Examples highlighted by LSN include Wagners (ASX: WGN), which supplies construction materials and infrastructure components, and NRW Holdings (ASX: NWH), a mining services contractor benefiting from rising activity across the resources sector.

Southern Cross Electrical Engineering (ASX: SXE) is another beneficiary through its involvement in electrification and data centre infrastructure.

These businesses may not capture headlines in the same way as technology stocks, but they sit directly in the path of a multi-year investment cycle.

Where to from here? The stocks on the watchlist

LSN are deliberate about not chasing momentum. The portfolio rotation they’re executing – reducing materials, into derated quality – is a medium-term thesis, not a short-term trade. But the current setup across several names is, in their words, as attractive as it’s been in years.

"There are businesses that reported better than expected earnings and saw upgrades post results. And that usually is a lead indicator for strong share price performance."

Beyond Megaport and the industrial names already mentioned, several other companies feature prominently within the portfolio.

Duratec (ASX:DUR). An engineering and asset remediation contractor specialising in defence, mining, infrastructure and marine projects, providing maintenance, protection and upgrade services to extend the life of critical assets across Australia, which has several significant contract opportunities.

AUB Group (ASX: AUB). An insurance broking business that received a $45 takeover offer two months ago before selling off to below $25 after an offshore article suggested AI would disrupt the insurance broking industry. LSN view this as a textbook overreaction. The stock is trading at its cheapest multiple on record while forecast to deliver at least 10% growth next year.

NRW Holdings (ASX: NWH). A mining services business with direct exposure to the gold, copper and broader commodity CapEx cycle. Its result came in ahead of expectations and guidance was lifted. LSN believe current forecasts "probably don't fully reflect the strength of the cycle."

Codan (ASX: CDA). MineLab, their metal detection division, is benefiting directly from elevated gold prices and new product releases. Revenue up 21%, EPS up 42%, post-result revisions up 8%.

Praemium (ASX: PPS). An investment platform provider that has taken a significant IT cost base out of the business. FY27 earnings growth is forecast above 30%, which LSN consider conservative.