Small caps suffer from a range of limitations to investment, but most of the time, these limitations have nothing to do with the quality of the business.
As a basic rule, retail investors like you and I will not invest in a stock that we know nothing about. But in the same vein, journalists and newspapers will cover stocks that are widely held or well known to sell more papers or generate more "clicks" online.
As a result, the Big 4 Banks, the supermarket stocks and the mining majors get a disproportionate amount of coverage because they are so widely held, which reinforces the coverage gap relative to smaller stocks.
But digging deeper can unearth much smaller businesses that have dominant positions in their industries, and can make wonderful investments as a result. Here are three candidates that fit that criteria perfectly.
Capilano Honey Ltd (ASX: CZZ) shares have tripled over the course of the last year alone. One major reason for this spike in the price is a mysterious disease that is affecting bees across the world. The disease is resulting in entire hives collapsing and their bees dying, which has serious negative effects for the supply of honey.
This has the effect of constraining supply and making reliable sources of the product like the hives operated by Capilano much more sought after. In addition, honey consumption is experiencing a resurgence in demand in Australia as a replacement for processed sugar and artificial sweeteners.
Capilano has capitalised on these macroeconomic factors and removed its cheaper "bulk" packs from supermarkets, which underpinned a 70% rise in net profit.
Beacon Lighting Group Ltd (ASX: BLX) was one of the most successful share market debuts of 2014. Unlike many IPOs in recent years, the share offer for Beacon was an orderly sell down by a founding family, rather than an overpriced private equity exit.
Beacon dominates the home lighting niche in Australia, as the only truly national player. It operates a vertically integrated model where it designs "fashion lighting" and has contract manufacturing partners in China create the end product.
The model underpins a high margin and high turnover business, and is similar to that used by successful fast fashion retailers like Spain's Zara. It also led to same store sales growth of over 10% and net profit growth of over 43% compared to last year, which is hugely impressive for any retailer operating exclusively in Australia.
Sealink Travel Group Ltd (ASX: SLK) is another stock with several powerful tailwinds at the back of its boat fleet and business. The company operates a range of boat cruises and ferry services around Australia.
The dominant contributors to net profit are a ferry service to Kangaroo Island in South Australia which is an effective monopoly of the company, as well as cruises and ferry services on Sydney Harbour.
The lower Australian dollar is a huge positive for the company, as more international tourists come to Australia and increase their spending on tourist activities like harbour cruises while here. The collapse in world oil prices has also been a boon for the company, as the cost of diesel is one of the major input costs for the company.
Higher passenger numbers and the ability to pass on fare increases to customers should also underpin rising profits in the years to come.
