Auscap sees a “fantastic decade” for active as it backs 6 ASX stocks poised for a snapback

Australian equities are throwing up some strange signals.

The largest companies on the ASX remain expensive. Resources have enjoyed a roaring run. Meanwhile, plenty of high-quality mid-cap industrials have been sold down heavily – even as their earnings continue to grow.

For active managers positioned away from the big end of town, it has been painful. The Auscap High Conviction Australian Equities Fund returned -8.9% in the year to 31 August, compared with a 3.5% gain for the All Ordinaries Accumulation Index.

But at a recent Auscap investor webinar, Portfolio Manager Tim Carleton said he believes the very forces driving that underperformance could be creating one of the most attractive environments for active investors in years.

Why passive investing could be creating opportunities

Carleton believes another powerful force is helping drive that disconnect: the extraordinary rise of passive investing.

In FY26, $15.5 billion flowed into passive Australian equity strategies, while $6.4 billion flowed out of active strategies, and those flows can have very real consequences for individual stocks.

Carleton points to Sonic Healthcare (ASX: SHL), where 14.4% of the company’s shares changed hands on 31 August during an MSCI rebalance, despite there being no earnings announcement or major company news driving the extraordinary turnover.

These huge flows are helping push share prices away from underlying earnings, but that disconnect can only stretch so far – as we saw with CSL (ASX: CSL) during the latest earnings season, when its shares roughly doubled from their lows as it became too cheap.

“It wouldn’t surprise me at all if we were sitting here in 10 years’ time and active managers had had a fantastic decade, because the starting point looks so extreme," Carleton says.

Many of Australia's largest companies are trading on elevated valuations despite relatively modest growth prospects. Elsewhere, companies continuing to grow earnings have become considerably cheaper.

“There are a lot of businesses that have been sold down very heavily but are continuing to grow their earnings very strongly. That disconnect, like a rubber band, can only go so far.”

6 ASX stocks Auscap is backing

So where is the Auscap team seeing opportunities?

A good chunk of them reside in the mid and small-cap space, where companies with growing earnings and strong fundamentals have been overlooked in favour of more expensive large caps.

STOCKS DISPLACED BY AI

One rich vein of opportunities is among companies perceived as potential AI losers, according to Auscap Deputy Portfolio Manager Will Mumford.

CAR Group (ASX: CAR) is one. Carleton argues its network effect remains formidable and believes AI could actually strengthen its moat through features including one-touch listings and 3D vehicle imagery.

Despite forecast earnings continuing to rise, CAR's share price and earnings multiple have fallen.

“We have been a buyer, adding to our exposure to CAR Group over the course of this year,” Carleton says.

Then there's ResMed (ASX: RMD / NYSE: RMD), a top-10 holding across both Auscap funds.

The sleep-apnoea giant continues to grow earnings, yet its valuation has contracted significantly. Carleton believes the growing ability of wearable devices to detect potential sleep apnoea could create another tailwind.

“We talked about exercise. We talked about diet. And now the market is moving to sleep,” he says.

Finally, Auscap has been adding to beaten-down IDP Education (ASX: IEL), where Carleton believes the international student cycle in major markets is at, or close to, a bottom.

And despite IDP recently rejecting a $2.50-a-share takeover proposal from Blackstone, Carleton believes the potential value is substantially higher.

“Our view of fair value for that business is many multiples of the current share price. We're not looking for a 20% or 30% premium.”

Why Auscap is cautious on gold

One area where Auscap is considerably less enthusiastic is gold.

Carleton understands the macro case. Large government deficits and concerns about currency debasement have helped propel gold higher, while Australian gold miners have enjoyed a significant earnings tailwind.

But he points out that gold miners have historically generated relatively poor returns on equity, with 2025 the first year in two decades that the sector collectively produced a double-digit return on equity.

And after the extraordinary move in the gold price, Auscap is wary of extrapolating those returns.

“What you often see after the gold price has had a significant move is an amazing ability for costs to expand at just as quick a rate.”

If gold retreats while those higher costs remain, profitability can get squeezed quickly. And for all the talk of gold miners seeing the benefits of operating leverage as prices rise, the domestic sector offers a chequered history of delivering return on equity.

“So we are cautious on gold,” Carleton says.

Eventually, earnings win

Ultimately, Auscap's thesis comes back to something much simpler: earnings and dividends, and to show the long-term connection of these metrics, he points to JB Hi-Fi (ASX: JBH) as the proof.

Since listing in 2003, its share price has increased around 43-fold. Its earnings? Roughly 44-fold. This is despite dramatic corrections in the electronic retailer's share price over that time.

“The fundamental driver – the reason that JB's share price is up 43-fold since it listed in 2003 – is the fact that its earnings are up 44-fold over the same period.”

That is why Auscap isn't responding to its recent underperformance by changing its investment philosophy.

If today's gulf between valuations and earnings eventually closes, the difficult environment confronting active managers may turn out to have created precisely the opportunities Carleton believes could underpin that “fantastic decade”.