The 14 stocks Bell Potter is backing amid a small cap resurgence

Following a prolonged period of underperformance compared to their larger peers, small caps are back in vogue according to new research.

So far, the Small Ordinaries has outpaced the ASX 100 by approximately 16% this year.

However, this has largely been driven by the resources sector, fuelled by soaring gold prices – small resources have outperformed their larger counterparts by close to 40%.

Bell Potter believes that this could only be the start of a resurgence in small caps.

There are three core reasons behind this belief:

1. Small-cap outperformance can broaden from resources to industrials;
2. More RBA rate cuts in the next 12 months will continue to provide a tailwind for small caps;
3. Small caps offering better fundamentals, with lower valuations and growth on offer.

Based on Bell Potter’s research, it believes that small-cap stocks on the ASX are currently trading at approximately 10% cheaper than large caps on a PE basis, with nearly all sectors trading on a discounted basis.

This is a gap Bell Potter believes could soon close.

“We think small caps can close the valuation gap due to the superior growth prospects inherent in the small-cap universe; these companies are often more nimble and can grow earnings from a much smaller base than their mature, large-cap, counterparts.”

According to Bell Potter, the valuation of the below small caps doesn’t make sense.

Centuria Capital Group (ASX: CNI)

When compared to a larger peer in the property investment and funds management space, such as Charter Hall Group (ASX: CHC), Centuria offers “compelling relative value” according to the broker and research house. In fact, Charter Hall currently trades on a PE multiple around 49% higher than Centuria despite both being similar businesses. 

While Bell Potter believes Charter Hall should trade at a premium, it believes the current gap is too large and should narrow.

Macmahon Holdings (ASX: MAH)

With diversified mining services company, Perenti (ASX: PRN), being included in the ASX 200, its share price has benefited from passive index flows. This has, according to Bell Potter, caused Perenti’s share price to trade at an unwarranted premium to Macmahon. 

In fact, it believes current prices offer an opportune time to take profits in Perenti and rotate into Macmahon, which offers similar exposure to contract mining with a primary focus on gold.

Generation Development Group (ASX: GDG) and Praemium (ASX: PPS)

One area that stands out to Bell Potter is smaller-cap wealth managers. Like the much larger Hub24 (ASX: HUB) and Netwealth (ASX: NWL), companies like Generation Development Group and Praemium are leveraged to market performance and capital inflows. Given market performance tends to be similar across companies, value is likely to be driven by the ability of these funds to attract new funds.

In GDG’s case, Bell Potter expects it to generate more than double the net flows as a percentage of funds under administration as its larger peers, despite trading on a similar PE multiple. Praemium, on the other hand, continues to trade at a material discount to its larger peers despite win new contracts and attract higher degrees of inflows.

Bell Potter’s (other) top small caps

On top of the above examples of what Bell Potter believes is undervaluation, it also provided an expanded and diverse list of its preferred small cap stocks.

While two resource companies made the list, Develop Global (ASX: DVP) and Nickel Industries (ASX: NIC), the bulk of the list reflects Bell Potter’s view that industrials rather than resources are where the best small cap opportunities can be found.

Such names include accident repair group AMA Group (ASX: AMA), cheese producer Bega Cheese (ASX: BGA), financial services company Cuscal (ASX: CCL), property developer Cedar Woods (ASX: CWP), agriculture stalwart Elders (ASX: ELD), medical imaging firm Integral Diagnostics (ASX: IDX), enterprise software company Kinatico (ASX: KYP) and fashion retailer Universal Stores (ASX: UNI).