Analysts agree, the S&P/ASX 200 (ASX: XJO) (Index: ^AXJO) is still undervalued. But in this Fool's opinion, many blue chips such as the banks, big retailers and now the miners are overpriced. In the past year, investors have forced the S&P/ASX 20 (ASX: XTL) to unsustainable highs as they've gone in search of a 'safe' place to put their money.
Source: Google Finance
Compared to small caps, a commonly held belief (that often proves to be painfully wrong) is that blue chip stocks like Commonwealth Bank (ASX: CBA) or ANZ (ASX: ANZ) are immune to potentially massive falls in share price. When interest rates are low, everyone goes in search of yield and security from big name companies but it can be disastrous for your profit and loss.
As you can see from the chart above, both blue chips (blue line) and small-caps (red line) on the ASX took a beating in the past few months as panicked term deposit holders flocked to equity markets in search of yield. However, small cap stocks pay just as good dividends as blue chips, provide much more growth potential and are comparatively cheaper.
Three small-cap stocks that have either been on my watchlist or in my portfolio since the beginning of 2013 are Mortgage Choice (ASX: MOC), M2 Telecommunications (ASX: MTU) and IMF Australia (ASX: IMF).
Source: Google Finance
Although each stock has risen substantially in the past 12 months, they are still well priced considering their potential for long-term growth. With interest rates at 2.5% and likely to stay low until the RBA perceives the economy has reacted to the easing, high yielding stocks will get driven up in coming months but blue chips won't have the results to back up the gains.
Foolish takeaway
In the current market, finding good stocks that represent value for money and have stable yields is important. Despite their small market capitalisations Mortgage Choice, IMF and M2 pay fully franked dividends of 4.9%, 5.1% and 2.7% respectively and provide a much greater upside for those investors willing to take on the perceived extra risk.
These 3 stocks have great yields and a strong upside but if you're interested in the Motley Fool's Number 1 dividend idea for 2013-2014, simply click here for your FREE copy of "The Motley Fool's Top Dividend Stock for 2013-2014."
More reading
- 3 stocks you'd love to buy, buy shouldn't
- 4 stocks for the falling Aussie dollar
- 3 ASX stocks you should have bought a year ago
Motley Fool contributor Owen Raszkiewicz owns shares in IMF Australia, Mortgage Choice and M2 Telecommunications.
