While the Small Ords Index is trading on a similar price earnings (P/E) ratio to the ASX 100, the former is set to outperform in the years ahead, new figures from Firetrail Investments have shown.
Namely, the firm’s latest data points to a three-year forward earnings growth for small ordinaries (14 per cent) sixfold to that of Australia’s largest companies (2.1 per cent).
“The asset class that we are most excited about at Firetrail going into 2024 is the Aussie small caps space,” investment specialist Chris Robinson said in Firetrail’s latest market outlook.
Looking across various small-cap sectors, the investment manager observed a healthy earnings outlook across all areas, but with notable contributions from materials, healthcare, and technology.
“With materials and healthcare being some of the worst performers last year, we are finding some really interesting bottom-up opportunities within this space,” Mr Robinson said.
He continued: “We think it’s important for investors to have exposure to participate in that growth.”
Looking towards global small caps, American Century Investments agreed that the asset class is set to outperform in 2024 despite having “borne the brunt” of worries about inflation, rising interest rates, and slowing economic growth over the last three years.
“As we open 2024, indications that inflation is easing have again raised hopes for a sustained pause in global central bank rate hikes. We believe this could produce a more favourable backdrop for global small caps and allow investors to refocus on earnings growth as the key driver of stock prices,” American Century added.
The historically low valuations for global small caps relative to their large cap counterparts, the firm highlighted, may be especially compelling for investors.
Based on consensus earnings per share, it further expects small-cap profits to grow faster than large-cap profits in most regions in 2024.
“In addition, the headwinds of rising interest rates faced by small caps – especially small-cap growth stocks – appear to be on track to diminish or reverse,” American Century identified in a market outlook this week.
“Such a shift could enable investors to turn their focus from central bank policy to corporate profits, creating a more favourable environment for active security selection. Longer-term, we believe investors will reward companies with improving earnings growth.”
Moreover, merger and acquisition (M7A) activity sat at a near 25-year low throughout 2022 and 2023, likely resulting in pent-up demand from acquirers.
As such, American Century is expecting to see a positive turn in activity in 2024 as financing visibility improves and larger firms seek to boost organic growth rates, with an improving M&A outlook often translating to favourable outcomes for small-cap investors, who are often key beneficiaries of these deals.
The firm continued: “While near-term volatility is possible, we continue to identify small-cap companies that we believe have the potential to deliver accelerating and sustainable earnings growth. Stable or declining interest rates may continue to provide a tailwind for small-cap markets.
“We believe bottom-up stock selection and prudent diversification remain critical as we continue to find growth opportunities across various sectors and geographies.”
