The best way to beat the broader ASX market return could be with ASX small caps.
Smaller businesses have much bigger growth potential than large ones. Commonwealth Bank of Australia (ASX: CBA) is already the biggest business in Australia, it's not like it is a start-up bank with years potential growth ahead whilst it spreads across the country.
Smaller businesses with long growth potential could be a winning combination.
If I were given $5,000 to invest in small cap ASX shares these would be the ones I'd go for:
Paragon Care Ltd (ASX: PGC) – $2,500
Paragon is a healthcare product distributor for items like beds, surgery equipment and devices. It has an online platform, kind of like a healthcare version of Amazon, for its clients to order whatever items are needed. This has good potential for automation and efficiencies to increase the profit margin over time.
The number of people over 65 are projected to grow by 40% over the next decade and 70% over two decades. This should lead to growing demand for Paragon's products over time. The ageing tailwind is very good for businesses that can use it to grow profit.
It's trading at 8x FY19's estimated earnings with a grossed-up dividend yield of 7.6%.
Duxton Water Ltd (ASX: D2O) – $1,000
Duxton Water is the only company in the world which purely owns water entitlements. It's not the most exciting business, but it could be one of those slow-and-steady growers if water values keep going up.
Australia's agricultural industry is increasing the amount of exports to international markets, so Duxton Water could be a good way to indirectly benefit from this.
There is currently a drought in regional Australia, but I wouldn't expect this to always be the case. In a rainy season water values could fall, so I'd only commit to a smaller purchase at this stage.
Duxton Water is trading at a slight premium to the underlying value per share and has a partially franked dividend yield of 3.5%.
WAM Microcap Limited (ASX: WMI) – $1,500
If you want exposure to ASX small caps but aren't confident with picking them yourself then going for a market-beating investment team then can do the job for you could be a good idea.
WAM Microcap is run by the high-performing team at Wilson Asset Management, it invests in businesses with market capitalisations under $300 million at the time of acquisition.
Since inception in June 2017 it has produced an average return per annum of 14% before fees and expenses, although FY19 has not been kind to the small cap manager – its portfolio is down 6.2%, although it's still outperforming the market.
It's trading at a 5% premium to the underlying value per share of $1.19 reported at the end of December 2018. It has an ordinary grossed-up dividend yield of 4.6%.
Foolish takeaway
Each of these businesses could beat the market over the long-term if they meet their potential. At the current prices it seems like Paragon is trading very cheaply, assuming it reports revenue and profit growth in FY19.
