According to Jason Zweig, author and financial journalist for the Wall Street Journal, small-cap stocks can provide opportunities, especially when markets are overvalued.
Along with this, a report from Data61 states that tech innovation in Australia is projected to have a AU$315 billion impact on the overall economy over the next 10 years.
With the WAAAX companies — WiseTech (ASX:WTC), Afterpay (ASX:APT), Altium (ASX:ALU), Appen (ASX:APX) and Xero (ASX:XRO) — reaching record valuations, small-cap tech stocks are a new market segment for investors to find both growth opportunities and discounted valuations.
Though they are sometimes overshadowed by Australia’s dominating resource and mining sector, just over 50 small-cap tech companies are listed on the Australian Stock Exchange (ASX).
Here the Investing News Network outlines some of the pros and cons of investing in this market segment, and highlights some of the small-cap ASX tech stocks available for investors.
Pros of investing in small-cap ASX tech stocks
According to Dominic Rose, portfolio manager at Montgomery Investment Management, three key growth themes have emerged for small-cap tech companies on the ASX.
First, Rose points out that the ASX has become an attractive market for tech due to lower listing costs and stronger investor appetite in the sector. Additionally, tech’s inherently disruptive nature can lead to structural change driven by innovation. Paving the way in tech specifically are cloud, software-as-a-service (SaaS) and artificial intelligence (AI) companies.
For example, as enterprises transition from localized servers to the cloud, new growth opportunities are cropping up. 5G Networks (ASX:5GN) has emerged as one key player in this market. 5G Networks provides cloud, hybrid and data centre services to help usher in this transition for businesses.
Secondly, fintech is a subsector of tech that presents a major area for growth potential in small-cap companies. The digital platforms embedded in many fintech business models are fast, agile and create a more engaging customer experience.
As Rose points out, independent wealth platforms in Australia — such as HUB 24 (ASX:HUB) and Praemium (ASX:PPS) — are giving legacy platforms a run for their money. Small-cap fintech companies in payments, blockchain and ewallets are also ripe for growth in Australia, says Rose.
Lastly, investment from investors in the Asia Pacific is projected to grow as the middle class continues to emerge and as investors seek out new business opportunities.
This is coupled with the growing trend of ecommerce platforms such as Alibaba (NYSE:BABA) and JD.com (NASDAQ:JD) gaining a greater share of the retail market. Interestingly, this trend could be accentuated by the ongoing trade war between the US and China, posing an opportunity for Australian markets.
Cons of investing in small-cap ASX tech stocks
Unsurprisingly, there are a number of cons associated with investing in small-cap tech stocks on the ASX.
For example, forward earnings cuts, downward revisions to gross domestic product and consensus forward earnings per share downgrades can figure prominently into the share prices of small-cap firms.
What’s more, risks increase when small-cap companies report net losses, large amounts of debt, negative cash balances or recurring negative revenues.
One way to minimize the risk when investing in small-cap tech stocks is to do your research. Examine company balance sheets and watch whether the company is posting a positive net income, positive cash balances and growing revenues. It is also important to evaluate the strength of the company’s management team.
Overview of small-cap ASX tech stocks
While tech companies make up only a fraction of the ASX, there are a number of small-cap tech stocks for investors to watch for. Several are listed below — all companies listed were taken from this list and had market caps between AU$50 million and AU$500 million as of October 29, 2019.
- Dubber (ASX:DUB): Dubber is a cloud-based software company that provides call recording software for businesses. Additionally, Dubber analyses customer calls using AI. To do so, the company takes note of customer sentiment, emotion and language and integrates this into customer relationship management platforms.
- Aeeris (ASX:AER): This is a security analytics firm that provides early warning network services focused specifically on geospatial hazards. Aeeris aggregates data to forecast hazards and severe weather and then provides hazard alerts to people and businesses in affected areas.
- 5G Networks: As mentioned above, 5G Networks owns 600 data racks across its data centres in Sydney, Adelaide and Melbourne. It is introducing wholesale data centre services in combination with cloud services and fibre networks to its client base.
- Animoca Brands (ASX:AB1): Animoca Brands is a gaming company that runs games such as F1 Delta Time, Crazy Kings and The Sandbox. The company has faced some scrutiny from the ASX surrounding a capital raise for a proposed acquisition, resulting in a suspension of trading in September.
- Aeris Environmental (ASX:AEI): Aeris Environmental provides HVAC energy solutions through its proprietary real-time analytics technology. It has a market cap of AU$51.23 million and is integrating location-based facility management services into its business model.
ASX small-cap funds
Investors who don’t want to invest in individual small-cap tech stocks on the ASX might consider funds focused on this area. For example, Colonial First State Smaller Companies is a fund that invests in Australian small caps that have consistent earnings and strong financials. The fund has achieved a 12.8 percent annual return over the past five years.
“The focus remains on unearthing companies with sustainable competitive advantages, but the emphasis on balance-sheet strength and cash flow has increased,” Anshula Venkataraman, analyst, manager research, at Morningstar, said regarding the fund.
There is also the Pengana Emerging Companies Fund. It takes an active approach, investing in companies that are income generating. Since its inception in 2004, this fund has reported an annualized return of 13.48 percent. Included in its holdings is Smartgroup (ASX:SIQ), an online salary packaging company.
In addition to these funds are a number of exchange-traded funds that provide exposure to this market segment, such as the BetaShares Australian Small Companies Select Fund (ASX:SMLL) and the Vanguard MSCI Australian Small Companies Index (ASX:VSO).
When it comes to mutual funds and other investment funds in the small-cap sector, Investors Mutual Australian Smaller Companies has seen annual returns of over 14 percent since 1998. It holds shares of fintech company Appen, location data company Nearmaps (ASX:NEA) and SpeedCast (ASX:SDA), a satellite communication company.
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Securities Disclosure: I, Dorothy Neufeld, hold no direct investment interest in any company mentioned in this article.