Small caps land is the place to be with these market juniors punching well above their weight over the past year compared to their bigger counterparts.
It's little wonder if you look at the FY18 earnings growth profile for both groups. While stocks in the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) are tipped to increase their earnings per share (EPS) by around a relatively pedestrian 6%, those in the S&P/ASX SMALL ORDINARIES (Index:^AXSO) (ASX:XSO) are forecast to deliver EPS growth at about the 10% mark.
This is one key reason why the Small Ordinaries has delivered gains of 17.5% over the past 12 months, when the top 200 stocks have only been able to pass a 2.9% increase.
You only need to look at the surge in the share prices of infant formula maker A2 Milk Company Ltd (ASX: A2M) and tech darling Altium Limited (ASX: ALU) to understand why emerging companies were the alphas of the ASX!
Growth-seeking investors are better off focusing more on the smaller end of the market as it is easier to find well priced stocks with double-digit earnings growth potential over the next two years.
I am not saying that the Small Ordinaries will continue to pull ahead of the ASX 200 after such a strong burst of outperformance, but investors with little or no exposure to small caps should re-think their strategy.
To help you along, UBS has scanned the small caps stocks under its coverage to pick three that have the most attractive valuations. The three stocks are:
- Eclipx Group Ltd (ECX): The fleet management company has started the year on a positive footing with the integration of the recent acquisitions of Grays and Car Buyers Australia performing well. UBS noted that industry sources have confirmed Eclipx's improved market performance in New Zealand, a robust second-hand car market (good for residual car values on its books) and market share gains in Australia. The stock is also trading on an attractive FY19 price earnings (P/E) multiple of around 11 times. UBS has a $4.55 price target on the stock.
- Adairs Ltd (ASX: ADH): UBS believes the homeware and home furnishings retailer will beat its FY18 guidance, thanks in part to growth in its online sales, upsized stores and its "buy now, pay later" program. The broker believes the retailer could realistically achieve 20% online sales penetration within 3 to 5 years. That's particularly pleasing given the high average online basket size per order. UBS has a $2.40 price target on Adairs.
- Reject Shop Ltd (ASX: TRS): The stock has swung back into favour after the discount variety chain posted a better-than-expected half year result last month. UBS thinks there is further upside for Reject Shop as it is forecasting improving margins of around 4% over the medium-term, compared to the 2.5% delivered in FY17. Management can squeeze greater efficiencies through its new Melbourne distribution centre and its direct sourcing of products from China. There is also potential upside from its new store format and refurbishment program. UBS has a $7.50 price target on the stock.
These aren't the only small caps that are poised to outperform in 2018. The experts at the Motley Fool have identified emerging stocks in a sector that they expect to make a big impact on investment markets this year and beyond.
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