Two small caps offering unrecognised earnings growth

COVID-19 was a hit to equity markets, as companies downgraded or withdrew their earnings guidance, and market uncertainty and volatility spiked. The sell-down in March has seen the market rebound more than 20% from its lows, and global small caps have more than kept up with this rally. So are there quality bargains in the large opportunity set that global small caps offers?

Three reasons to own global small caps

There is a compelling case to own small caps that is as much about their future growth trajectories as smaller companies becoming larger, as it is about the opportunity to participate in returns before most other investors. We think there are three major reasons people should be adding small caps to their portfolios.

Firstly, we've seen very strong returns for this asset class compound over the last 20 years. Global small caps have delivered twice the return of global large caps, even when adjusted for volatility. Global small caps are a great opportunity set, some 4,300 companies across 23 developed markets if you are using the MSCI Global Small Cap Index. These companies are under-researched, often misunderstood, and are yet to be discovered by the Street, leaving significant upside to early investors who are able to find the best of this group, and invest ahead of consensus – we call this the potential to capture unrecognised growth.

Secondly, we've recently seen the market converging and crowding into large caps, especially US large caps as people run for the comfort of familiar names, rather than look for long-term returns. The top five companies in the US now account for over 21% of the market capitalisation of the entire S&P 500 Index. The last time we saw this level of concentration was during the tech bubble in 2000. This type of concentration compels those seeking a diversified portfolio to look to smaller companies to balance out these enormous firms.

Thirdly, with the small-cap sector now trading at a significant discount to its highs of 2019, the opportunity is now to find and secure an investment in firms with earnings growth profiles with the potential to super-charge alpha returns over the next 5 – 10 years. Like almost all segments in the market, COVID-19 has seen prices of quality companies of all sizes fall well below their values, in many cases offering the best value for investing that we have seen in over a decade.

What do these opportunities look like and how can you find them? Here are two global small caps that we see as offering the unrecognised growth potential we seek through our process.

Two emerging global titans to watch

Solar Edge (NASDAQ: SEDG), is a maker of solar panel optimisers, inverters and batteries. It is listed in the US and it has a market cap of almost US$5 billion. SEDG optimises balance and power generated from solar panels, making them significantly more efficient while inverters allow the power that's generated from those solar panels to be used in the home, sold back to the grid, or stored in batteries. SEDG sell their products in Australia via well-known names like AGL. We really think Solar Edge is going to be a leader as we transition to the greater use of renewables, and shift towards more reliance on smart energy.

The company was founded in Israel in 2006, and has grown strongly since then. We think the global inverter market will continue to grow at about 20% a year. When you can combine this with ongoing energy demands, there is a strong thematic driving this name. We've been watching Solar Edge for a while, looking for an attractive entry point, which we got last month from the market drawdown. Solar Edge is potentially an emerging global titan as it not only holds dominant positions in its key markets of Europe and the US, but continues its expansion in Asia Pacific, Australia and Latin America.

Cirrus Logic (NASDAQ: CRUS) is a name we've held for a while, and which has performed well. Cirrus Logic is the niche leader in haptic drivers and voice biosecurity. What we really like about Cirrus Logic is where haptic drivers are going in terms of demand. A haptic driver is the software and the semiconductor that delivers the touch control of your smart phone, whether it's a Samsung android or an Apple iPhone.

This technology is seeing increased demand, not only in consumer electronics with phones and tablets, but also in across industry 4.0 applications and in automotives. CRUS is a business where management have consistently over-delivered. We believe the market is underestimating, and as a result, undervaluing the potential for revenue and earnings growth in Cirrus Logic, which is a classic example of the unrecognised growth that we seek.

Capitalise on undiscovered gems

Ausbil’s active global small cap investment process aims to exploit the inefficiencies within the asset class by investing in quality companies with unrecognised growth potential at attractive valuations. Click the 'CONTACT' button below to find out more.