Buy Hold Sell: How to play the small-cap rebound plus 4 stocks leading the way

Small caps are in comeback mode, and investors are starting to take notice. After years in the doldrums, this once-unloved corner of the market is showing real signs of life, with the index surging more than 20% year to date. But is this rally built on solid foundations, or is it just another short-term burst of optimism?

In this episode of Buy Hold Sell, host Anna Dadic is joined by Matt Griffin from Maple-Brown Abbott and Luke Laretive from Seneca to unpack what’s really driving the small-cap recovery and where the next wave of opportunity might lie.

From takeover activity heating up to renewed investor appetite for growth, our guests share their read on what’s changed, what still looks cheap, and the risks investors need to keep on their radar.

If you’ve been sitting on the fence about small caps, this episode is packed with insights to help you separate the real signals from the market noise.

This episode was filmed Wednesday, 8th October 025.

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Edited transcript

Anna Dadic: Hello and welcome to Buy Hold Sell. I'm Anna Dadic. Small caps are making a comeback with the index up 22% year to date. It's also one part of the market where active managers often shine. Joining me today are Matthew Griffin from Maple-Brown Abbott and Luke Laretive from Seneca to talk about what the drivers are to the small cap recovery and how they're finding the next big opportunities. Gentlemen, welcome to the show.

So Matthew, I'll start with you. A lot has been made of the difference between small cap and large cap performance recently. So is it just noise or is there real signal behind the market's reversion?

Is the small cap comeback signal or noise?

Matt Griffin: Yeah, I think there's real signal behind the narrative we've seen over the past few years. So if you wind back three or four years, we had a pretty tough start to small caps at the beginning of the decade after COVID. Interest rate rises, inflation, small cap earnings downgrades led a lot of investors to go to the large cap space, hide in a bit of safety and liquidity.

So the small cap index actually underperformed by 23% over the subsequent three years. What we've seen is that's been completely flipped on its head in the past couple of months. So from the start of August to now, we've had half of that underperformance made back in terms of small cap recovery. That's been driven by interest rate cuts coming through, better economic signals and an outlook for small cap earnings that is far better than large caps over the next one or two years.

So I think that recovery has been well received by the market. I think provided the economic backdrop stays as it is, there's no reason why we can't make back the rest of that underperformance over the next, say, 12 months.

Anna Dadic: Okay. Luke, what's your take?

Luke Laretive: Completely agree. I think there's been a small cap bear market for a number of years and we're really just halfway or maybe not even halfway to the catch up trade. As Matt's alluded to, the earnings outlook in smalls is much better than it is in large caps. The values are similar both on about 20 times, but smalls typically trade at a premium if they're growing faster and doing better and often delivering high quality. So I don't see any reason why we can't have another good at least two, maybe even three or four years of small cap outperformance.

Anna Dadic: So Luke, from what you are seeing and hearing from companies, is there fundamental evidence to back up the recovery?

Luke Laretive: I think so. There's companies doing pretty well. I mean you can look at the gold sector, record cash flows and higher-for-longer prices and that's like 11% of the index. Stable or falling interest rates is pretty supportive for REITs - that's 14% of the small cap index.

Outside of that, the tech space has been doing quite well and they've gone through this leaning-out period when rates were higher and all of a sudden were asked to focus on profitability, they got lean and now they're making record cashflow quarter after quarter.

So I think from our perspective there's a lot to like about a lot of the data that's coming through. You might not want to be in consumer discretionary names and some of that household spending stuff might be struggling a little bit, but outside of that corner of the market, there's a lot to like in smalls at the moment, a lot of data to support it.

Anna Dadic: Matthew, what's your take?

Matt Griffin: Yeah, I fully agree with what Luke said. So if you look at small caps over the past year, it's really been driven by three major thematics: gold, tech and defence. I think what we've seen at the last reporting season, the last set of results, is more of a broad-based recovery start to play through.

So if you look at a lot of the retailers are actually starting to report positive sales. As I said, it's still pretty tough out there. It's not uniform, but it's enough to get margins back to where they have been and overcome some of the cost challenges they've had. And so there's a bit of a brighter outlook there.

Some of the small cap financial players, the buy now pay later firms, the non-bank financials are seeing very low levels of consumer bad debts and delinquencies. So household balance sheets are in pretty good shape out there as well. And I think more broadly across the economy, if you look at some of the industrial and mining services-related businesses, they're reporting record order books, plenty of work starting to come through, favourable contract terms.

So we're seeing the miners and governments essentially go forward with projects in energy, mining, water, power, infrastructure type spaces. So that's just a broad based economic recovery that we're starting to see the green sheets come through.

Where are the potential headwinds?

Anna Dadic: Staying with you, the narrative around small caps has turned decidedly bullish, but let's flip it. What are some scenarios you are thinking about that could create headwinds and how are you thinking about it?

Matt Griffin: Yeah, it's an interesting one. I mean, I'm very much a stock picker. I'm not an economist. So take whatever I say about the economy with a grain of salt. If you wanted to make a bear case for small caps, you would look back three or four years and see what happened back then and that might repeat. So if the interest rate cuts stopped coming through, if people start worrying about inflation or start worrying about recessions again that's a negative environment for small caps, you start to get a bit worried. There's a few things we're monitoring on that front. Some of the employment indicators in the US look like they're turning a bit. So rising youth unemployment, job opening numbers falling slightly.

In Australia, we are probably seeing less interest rate cuts now coming through than we thought we would a few months ago. So that cycle might be shallower than what it has been before. A couple of those things are warning signs, but I don't think there's anything concrete enough to derail the bull thesis at this point.

In small caps, we are always worried about downside protection. It is a very volatile sector. I've been through the GFC and COVID and a few other cycles. So we always have a firm line on risk management on the stock side and make sure there's an element of downside protection in the fund, because typically these issues rear their heads when you least expect them. So you've always got to be prepared.

Anna Dadic: Of course. Luke, what's your take?

Luke Laretive: I think smalls are inherently exposed to the cost of capital more so than large caps, often because they're not generating enough cashflow to self-sustain themselves in the aggregate more so than large caps. So Matt's right interest rates or changing cost to capital is going to be the main driver for a bear market in smalls.

I don't think that's going to happen at the moment, but Matt was pointing out, the US economy does look to have some warning signs about it and certainly rising inequality, civil unrest, these things are all prevalent in today's society and could potentially create inflation or greater unemployment, which would maybe derail our thesis a little bit.

Anna Dadic: So Luke, where are things getting too hot or frothy?

Luke Laretive: Probably I think these thematic driven ideas around critical minerals, what governments are going to do in different jurisdictions, or defence spending. I think that there's certainly that COVID-like speculative behaviour coming back into this market. We're starting to see some stocks absolutely moon on the back of no earnings, no revenue or very limited given the valuations that are getting applied to these companies.

So I think investors need to be careful in chasing some of these thematic ideas and probably as Matt would agree, just stick to the fundamentals and that typically works on a through-the-cycle basis rather than just trying to ride the momentum of a given moment.

Anna Dadic: Yeah, sure. Matthew, what's your take on that?

Matt Griffin: I do agree with that. Typically in small caps, what you see in the bull market is the areas that get a bit frothy are the biotechs and mining explorers. Certainly seeing that at the moment. So plenty of those companies have billion dollar plus market caps with no revenue. My experience in the markets would suggest that the vast majority of new drugs don't make it through all the clinical trial gates and FDA approval and the vast majority of good drill holes never turn into a mine.

So while there can be a lot of money to be made in these stocks, I think they're more trading stocks than actual long-term buy and holds. The other area, I mean there's a lot of people talking about whether there's an AI bubble or not, I’m yet to make up my mind - there are earnings coming through. So despite how much everything's run, the earnings actually have kept up.

What I'm a bit worried about is we're seeing tech companies being valued on sales multiples, people talking about total addressable markets, earnings and cashflow sort of out the window for these stocks. We saw this in 2021 and, right before that, we had a big downturn in that sector. So we have been trimming some of the high growth speculative tech stocks in the fund and moving more towards the boring low growth, dependable type businesses.

The outlook for M&A

Anna Dadic: Staying with you, Matt, M&A has been a key feature in the market. What's been driving it and do you expect it to continue?

Matt Griffin: Yeah, it's interesting. So I think what's been driving it has just been that small caps have been really cheap for the last few years. Aussie small caps to be left behind by large caps, global markets, private capital, weak Aussie dollar has helped. We've seen a lot of foreign US private equity firms come in and acquire especially micro cap and the small end of the small cap index. I actually think that's going to flip on its head a bit.

So we've had a decent recovery in the markets. Valuations are back to historical levels. I think rather than seeing buybacks in inbound M&A, I think we're going to see more companies raising money to acquire their own businesses and look for growth angles and I think we're going to actually see IPOs come back.

So there's quite a big IPO pipeline shaping up towards the end of the year. So I think that whole equation will potentially shift the other way and we'll start to see listed businesses grow again and start to acquire themselves.

Anna Dadic: Yeah, sure. Luke, are you seeing the same thing?

Luke Laretive: Yeah, to a degree. I think takeovers and identifying companies that can get a bid has been key to us driving returns for the last 24 months. I think we've had five or six different companies go out of our portfolio. I don't necessarily think that that's going to slow down. I think as long as we're seeing cost of capital stable and falling down in some sectors, in certain industries, it's going to be cheaper to buy than to build.

It's going to be cheaper to bolt on or merge, particularly in the mining sector and resources sector. I think that that's where the opportunities lie. We've still got a number of potential M&A targets in our portfolio and still fairly confident that we can see a couple of those go maybe even before the end of the year. So I wouldn't say that M&A is out, but I would say that like you have to be as an investor - probably the buyers are going to be a little bit more discerning, a little bit more focused on price, a little bit more harder on due diligence. It's not going to just be buy this, it's dirt cheap. They're going to be really focused on the strategic value of those acquisitions.

Stock picks - biggest performance drivers

Anna Dadic: So staying with you, could you share the two biggest contributors to your performance over the past 12 months? Are they still in the portfolio today?

Energy One (ASX: EOL)

Luke Laretive: Yeah, they're both still in there. So Energy One, I think that's up 250 odd percent. They're the Iress for electricity traders. Essentially it's been a business that had a little bit of a chequered history, some cybersecurity issues, missed earnings back in the past, and I think the stock was five or six bucks when we first bought it. It's since recovered, inflected into profitability and rolled out into this typical Seneca playbook that is the way that we invest.

Catapult Sports (ASX: CAT)

Catapult - very similar. It was hated by the market, it was trading at two bucks. They'd been able to build the market's confidence by demonstrating they can grow top line without necessarily growing the bottom line at the same rate. So that business is now going into global dominance in what is a continually growing and more valuable addressable market.

Anna Dadic: Matt, what are your two top performers?

Genesis Minerals (ASX: GMD)

Matt Griffin: Yeah, number one is Genesis Minerals. That's still in the fund today and still one of our preferred ways to play the gold thematic. What Genesis offers is a management team that's got a track record almost second-to-none in the industry in terms of shareholder value creation. They've got a very well mapped out growth path over the next four to five years and we think there's areas they can outperform on a number of metrics over that time period.

And importantly, a very big resource base, I think there's 15 or 16 million ounces they've got in the ground. There's only a fraction of that actually captured in the mine plan. So I don't think the market's fully got its head around what that could mean in terms of future optionality and new production hubs for the business.

Perenti Ltd (ASX: PRN)

Number two is Perenti - mining services business through their Barminco underground contracting business primarily. This business had a really tough ‘23 and ‘24 and it shows how short-term focus the market can be. The market was worried about a couple of key contracts potentially not being renewed, cashflow being pushed out a bit.

We kept the faith, we were doubling down on the stock. It was trading on a multiple of four or five times, so absolutely dirt cheap. What they ended up delivering was contract renewals, cashflow better than the market thought, and a very solid earnings growth outlook as well. So it's rerated to 13 times today. It's probably closer to fair value. We still have it as a position of the fund. I do think that the next leg of growth is going to be driven by their drilling business. All this capital is being raised by junior miners will find its way into the ground as exploration over the next two or three years, and that's probably a source of earnings upside for them.

Anna Dadic: Okay, awesome. Thanks Matt and Luke for joining Buy Hold Sell today. That's all we have time for. If you like that interview, make sure to give it a like, and don't forget to subscribe to our YouTube channel. We release new content every week.