3 reasons why small-cap ASX shares could rocket in 2023

These stocks have been shunned in the face of high inflation, rising interest rates and a slowing economy. So how will they turn around?

| More on:
three children wearing superhero costumes, complete with masks, pose with hands on hips wearing capes and sneakers on a running track.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Small-cap ASX shares have really been on the nose in the past year as valuations have plummeted in the face of raging inflation and the fear of an economic slowdown.

And with much of the world facing financial troubles in 2023, many experts are still advising investors to stay away in favour of defensive value stocks.

But Forager Funds chief investment officer Steve Johnson, in a report to clients, reckoned that small caps could see a massive turnaround this year.

"That might seem counterintuitive. Everyone is telling you to buy defensive, resilient businesses, right?

"Well, in and of itself, what everyone is telling you is often a good contrarian indicator. But global small-cap fund manager Global Alpha recently released research suggesting there is more to my question than a simple contrarian viewpoint."

'Undemanding valuations' combined with recession resilience

For Johnson, three positives make small-cap ASX shares a tempting choice at the moment.

Firstly, small-cap stocks are starting 2023 from a very low base.

"The S&P/ASX Small Ordinaries (ASX: XSO) was down 21% for 2022, versus an All Ordinaries (ASX: XAO) that was down just 7%. For non-mining companies, the performance was even worse," said Johnson.

"That leaves us with some undemanding valuations. And starting prices matter more than anything else."

Secondly, Johnson argues against the stereotype that large companies are better placed to withstand economic downturns.

"Small companies tend to perform better in a recession than most investors anticipate," he said.

"They can be nimble and agile and are often run by a founder or significant shareholder who has a strong incentive to make tough decisions early."

Thirdly, acquisitions are "far more attractively priced" in periods of economic slowdowns, and smaller companies are much more likely to be involved.

"That is both for companies that are doing the acquiring and those that get bought," said Johnson.

"Our Forager Australian Shares Fund received takeover offers for five different companies in the second half of 2022, out of a portfolio of just 30 stocks."

It's this combination of low expectations built into the share prices and businesses performing through recessions that make small caps compelling at the moment.

And historically, judging from the Global Alpha research, small caps have outperformed large caps for years after the economic troubles have passed.

"In the US, small caps were the best-performing asset class for the five years post the 1973/4 market meltdown, through a recession and a decade of high inflation," said Johnson.

"My grandmother always tells me the secret to happiness is low expectations, though. The good news is that expectations are a lot lower today than they were just 12 months ago."

Should you invest $1,000 in S&P/ASX 200 right now?

Before you buy S&P/ASX 200 shares, consider this:

Motley Fool investing expert Scott Phillips just revealed what he believes are the 5 best stocks for investors to buy right now... and S&P/ASX 200 wasn't one of them.

The online investing service he’s run for over a decade, Motley Fool Share Advisor, has provided thousands of paying members with stock picks that have doubled, tripled or even more.*

And right now, Scott thinks there are 5 stocks that may be better buys...

See The 5 Stocks *Returns as of 7 February 2025

Motley Fool contributor Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Small Cap Shares

A man slumps crankily over his morning coffee as it pours with rain outside.
Small Cap Shares

Why this Telstra-linked ASX small cap stock just crashed 90%

This small cap is having a very bad session. What's going on?

Read more »

A young boy wearing a hat, sunnies and striped singlet looks fierce and flexes his arm in victory.
Small Cap Shares

The ASX small-cap stock trading at 'half of the earnings multiple of industry leaders'

A leading fund manager sees a lot of untapped value for this soaring ASX small-cap stock.

Read more »

A man has a surprised and relieved expression on his face. as he raises his hands up to his face in response to the high fluctuations in the Galileo share price today
Small Cap Shares

These small cap ASX stocks could rise 15% to 70%

Analysts think big returns could be on the cards for buyers of these stocks.

Read more »

A female ASX investor looks through a magnifying glass that enlarges her eye and holds her hand to her face with her mouth open as if looking at something of great interest or surprise.
Small Cap Shares

2 under-$5 ASX hidden gems worth your attention

These buy-rated shares are flying under the radar. Let's see why analysts are bullish on them.

Read more »

Miner looking at a tablet.
Resources Shares

2 small-cap ASX mining shares exploding 40%+ on China tariff news

Investors are sending the small-cap ASX mining shares flying higher on Wednesday.

Read more »

Siblings jumping on a trampoline.
Small Cap Shares

3 ASX small-cap shares with a 'solid growth outlook' for 2025

A leading fund manager expects strong growth from these ASX small-cap stocks in 2025.

Read more »

A little girl with red hair runs excitedly with a rocket strapped to her back, trying to launch.
Small Cap Shares

Guess which ASX small-cap stock exploded 154% on big US news!

ASX small-cap stocks carry added risk, but also sometimes offer supersized rewards.

Read more »

A group of businesspeople clapping.
Healthcare Shares

This fund returned 109% in 2024. Here are 2 of its best-performing ASX shares

Small caps proved to be the winners last year.

Read more »