Over the past five years, the S&P/ASX Small Ordinaries (Index^AXSO) (ASX: XSO) has underperformed the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) by nearly 40%.
The biggest drag on the small cap index's underperformance has been the capitulation of many junior and mid-tier energy and resource companies in the index. The sharp fall in commodity prices has seen many of the producers, explorers and service providers fall significantly in value over the last five years.
Despite the index's underwhelming performance as a whole, there have been some exceptional wealth creators in this sector of the market. Stocks like Blackmores Limited (ASX: BKL), M2 Group Ltd (ASX: MTU) and Sirtex Medical Limited (ASX: SRX) have been some of the best performers in the sector and owning just a couple of these stocks over the last couple of years will have helped investors to outperform the broader market.
It might be a little late to buy those three stocks, but there remains a number of high-quality small-cap stocks that could be great long-term investments.
So with that in mind, here are four small-cap stocks investors could consider adding to their portfolios:
1. Cover-More Group Ltd (ASX: CVO) – Cover-More is a leading integrated travel insurance and medical assistance business with strategic partnerships with some of the largest companies in the world. The company is building a strong reputation for consistent earnings growth and has a strong pipeline of international and domestic expansion plans in place. Although the shares are trading on a price-to-earnings (P/E) ratio of around 28, Cover-More has a number of industry tailwinds behind it and carries forward strong earnings momentum into FY16.
2. Automotive Group Holdings Ltd (ASX: AHG) – AHG is Australia's largest automotive retailer and the largest provider of temperature controlled logistic services in the country. The market is concerned about the slowing Western Australian and Queensland economies and the effect this might have on automotive sales, but at the current share price, these concerns appear fully priced in. The shares are trading on a P/E ratio of just 12 and investors can expect to receive a fully franked dividend yield of more than 6% based on analysts' forecasts.
3. McMillan Shakespeare Limited (ASX: MMS) – McMillan is a leading provider of salary packaging and motor vehicle leasing services in Australia and has also recently expanded its services into the UK market. McMillan reported a solid increase in FY15 net profit after tax to $67.5 million – an increase of 23% over the previous year. The company looks like it has fully recovered since the proposal to change salary packaging rules but there still remains the lingering threat of regulatory change. While this may limit the potential for explosive share price gains, McMillan still has a number of avenues for growth over the medium term. The share price has pulled back recently, and this could be viewed as a reasonable entry point to build a long-term position in the company.
4. Villa World Ltd (ASX: VLW) – The home builder has doubled its house production over the past three years and is set to build on this momentum in FY16 by delivering up to 40% more lots compared to FY15. The company recently released a first quarter update that showed the company has carried on strong momentum into the new financial year and is on track to meet its full year target range. Although a slowing housing property market remains a risk for Villa World, the shares appear undervalued at current prices, trading on a P/E ratio of just 8 and offering a fully franked dividend yield of more than 7.5%.
