The ASX small-cap gems Spheria is backing - and the metric that matters most

Please note this interview was filmed on Tuesday 14 April 2026.

A growing confluence of geopolitical uncertainty, ahistoric macro trends, changing investing behaviours and a wealth of data to contend with means finding a genuine edge is harder than ever for active investors. 

But stocks still take the market by surprise and opportunities will always present themselves to those who know where to look, says Marcus Burns, Spheria Asset Management's co-founder and portfolio manager.

"Hidden gems exist everywhere," he says. "There's hidden gems in large, there's hidden gems in mids, and obviously in smalls."

"And you've got to remember that a lot of all the large caps were once small caps and micro caps. So within that universe of names, there's always going to be businesses that thrive, that can disrupt and succeed based on good management and good niches. It's our job to try and pick those."

The job may be harder than ever, which is why the small-cap specialist remains committed to a bottom-up, fundamentals-driven approach for finding the great investments hiding in plain sight, across its Spheria Australian Smaller Companies Fund, and now its listed equivalent, the Spheria Australian Smaller Companies Fund - Active ETF (ASX: SPHX).

In this interview, Burns explains why cashflow is the one metric you need to pay attention to - and the stocks delivering on that front - and why in small caps, it's just as important to avoid the losers as it is picking the winners.

Finding opportunities amidst the noise

Burns says the recent geopolitical turmoil has come at a time when markets were already grappling with unprecedented levels of change.

"There's been more disruption occurring worldwide in businesses than I've ever seen in my career," he says.

"You've got autos being disrupted by China, you've got the telcos, you've got technology disruption, obviously. You've got funds management being disrupted to some extent. And down the pipeline, we've got AI."

It's a confronting task for investors looking to make sense of the noise. For Burns, it reinforces the need for discipline and adherence to a clear philosophy. 

"It really makes it a very challenging time to invest," he says. "What we recommend people to do, or what we do is anchor ourselves to a true north."

"Our core philosophy about cashflows and balance sheets and valuations, which underpin how we think, are what we go back to in challenging times. We try to root ourselves in that approach to build a portfolio that can survive and thrive in periods of change."

The one key metric really driving returns 

One of the key advantages and challenges of small cap investing is that its home to inherently high-achieving companies.

"We're fishing in a pond of outperformers to start with." 

But there's one measure that the data shows can help delineate the winners from the losers: free cashflow.

According to Spheria's analysis, it's the difference between vastly outperforming the Small Ords index over time, or vastly underperforming it.

"If you just had a portfolio of cashflow-generating companies compared to the Small Ordinaries, you massively outperformed." 

"And conversely, if you only bought cashflow losing businesses, you dramatically underperformed."

For Burns, free cashflow is a quantifiable measure that tells you a lot about both the potential direction of travel for a small cap stock, but also its durability during times of trouble. 

"Free cashflow is something you can actually measure and value," he says. 

"If you don't have free cashflow during challenging times, then businesses can obviously really struggle, and small-caps, unlike large-caps, find it hard to raise capital in challenging market environments."

"It's a better rock for us to value businesses by. It's also a survival mechanism for companies in more challenging environments, so it forms a core part of how we think and invest."

The small cap cashflow kings

Burns identifies three ASX small caps that Spheria have identified as strong cash flow generators.

The first is local fashion brand Universal Store Holdings (ASX: UNI), which Burns describes as a "really well-run business" that has average cashflow conversion of 96% over the last five years. 

Since listing six years ago, the stock has effectively doubled, generating an annualised compound return of 20% with strong dividends. 

The second stock is IMDEX Ltd (ASX: IMD), which provides mining technology tools that also boasts strong cashflow conversion, and has grown EBITA and free cashflow in recent years. 

The third is Eagers Automotive Ltd (ASX: APE), which has leading market share among car dealerships and has seen impressive returns in recent years.

Like IMDEX, it has been growing free cash flow and EBITA, whilst averaging 87% cash flow conversion. 

They're all examples of small-cap companies well-positioned for growth.

"All three names have got a good future ahead of them, good management teams and all generate great cashflows," he says. 

The stocks they've been adding

While market narratives remain driven by AI disruption and geopolitics, Spheria has moved into sectors that mark something of a departure for the fund, but are still driven by the same cashflow-driven focus.

"We've leaned a little bit into the harder assets and also the energy trade," says Burns. 

"We've been pretty underweight resources for most of our fund's existence, but over the last six months or so, we've been adding to that."

"We bought into Karoon Energy (ASX: KAR) late last year. It's a great cashflow-generating business, and that's been added and done pretty well. Obviously, we didn't predict the oil crisis, but it's been helpful for that period."

There's also been investments in certain infrastructure names that are tangentially benefitting from the macro trends shaping markets.

"We've bought into hard infrastructure like Channel Infrastructure NZ Limited (ASX: CHI), which was a New Zealand based oil refining business and is now an import and storage terminal based north of Auckland," says Burns. "That's a really good asset and really well run. Again, a good cash flow business, and right now right in the eye of the storm."

The other is IPD Group (ASX: IPG), which "effectively provides all the plumbing for electrical data centres and transformers and all the kit that goes into making electricity move around to the country and build networks."

Picking winners, avoiding losers

Every investor who's played small caps has got a litany of winners and some losers, unfortunately, and us included, says Burns.

"A lot of people look for the fence-hitting 10 bagger, which obviously is exciting and makes a good story around a barbecue. But we see our role as much about avoiding the losers as we do about picking the winners," he says.

In small-caps the margin for error is thinner, and bad investments can be severely punished. 

"Unlike large caps where the volatility or the potential outcomes are maybe 30-50% downside if you get something wrong, in small-caps - and particularly as you go down the spectrum to micros - the range of outcomes is larger," says Burns. 

"Losing 80-90% is a not-implausible outcome if you pick the wrong business at the wrong time. So our philosophy is built on trying to avoid those, shift those return profiles to the right and give people a better long-term, safer compound annual growth on their invested capital."

At a time when uncertainty reigns, remaining disciplined remains the best course of action. 

Sick of trying to pick small cap winners? Invest in SPHX

The Spheria Australian Smaller Companies Fund – Active ETF (ASX: SPHX) is a portfolio of small caps, selected by an award-winning investment team applying rigorous bottom-up analysis focused on free cash flow and strong balance sheets. Learn more here.