By Daniel Arbon
Retail investors can find opportunities and value at the tiny end of Australia’s sharemarket. Here’s how to get started on the stocks exciting microcap pickers.
The largest microcap on the ASX is about 1000 times smaller than the Commonwealth Bank of Australia.
For big institutional investors such as the superannuation funds, that’s too small to bother with. But for smaller investors, it can be a sweet spot.
Warren Buffett once said that if he only had $1 million to invest, he could return 50 per cent a year. He was confident he could profit from mispriced shares in tiny companies, but with billions to deploy, there wasn’t enough stock for him to buy.
Individual investors don’t have that problem. With a modest amount of capital and a willingness to do their homework, everyday investors could generate meaningful returns in the overlooked corners of the market.
Microcaps are usually defined as companies with a market capitalisation of less than $300 million. Small caps range from $300 million to $2 billion, mid-caps from $2 billion to $10 billion and large caps measure in tens or even hundreds of billions – $32 billion is needed to enter the ASX 50.
These thresholds are only rules of thumb, but they show how far microcaps sit from the market’s centre of gravity, where valuations are looking lofty. That is one reason why the conditions for microcaps are starting to look more favourable, says former fund manager Mark Tobin, who now runs his own portfolio and a specialist microcap newsletter.
“With equities hitting all-time highs in the ASX 200, people are starting to look down the ASX, trying to find a bit more value.”
Private equity and trade buyers have already been quietly picking off bargains at depressed valuations. Richard Ivers, a portfolio manager at Prime Value Asset Management, says the macroeconomic environment is also turning friendlier for small and microcaps, with interest rate easing likely to benefit the smaller end of the market most.
This is because, as interest rates fall, it becomes cheaper for small companies to borrow money to expand. “Just as we saw that part of the market underperform as the rate rising cycle started, we are now seeing them outperform in the cutting cycle,” Ivers says.
That backdrop makes the case for a closer look at microcaps, which are best assessed with these four considerations in mind:
1. Microcaps are overlooked – and that’s the opportunity
Microcaps make up three-quarters of all ASX listings but just 2 per cent of its market value: about $66 billion spread across roughly 1300 names. The sheer breadth of the microcap universe means most companies receive only limited attention. There are just too many names for analysts, fund managers or even the legions of retail investors to follow in depth.
“There’s just so many stocks down there, it’s impossible for anybody to fully keep track of,” says Tobin.
Analyst coverage is scarce, and the mainstream media rarely pays attention. But this, paradoxically, creates an edge for anyone willing to pick a handful of names and put in the work – reading announcements, tracking management and following results over time.
Naomi St John, an equity research analyst at broker Taylor Collison with a rare specialty in microcaps, says the lack of coverage is a feature, not a bug.
“For those able to dedicate the time to understanding the story, lack of analyst attention creates opportunity,” St John says. “An extensively covered stock is often accompanied by considerable noise, which can make it hard to distil the core drivers of the stock.”
It’s important to note, though, that thin coverage can also mean greater volatility. The phenomenon known as pumping and dumping – the co-ordinated inflation of a share price with hype before a sell-off en masse to exploit late buyers – is much more common in microcaps than in bigger companies.
“A company’s update on a contract win or loss may cause over-corrections of price if the importance of the contract is misunderstood by investors,” St John says.
So, keep calm and stay the course with high-conviction picks.
2. Exposure should be small – and active
No one is recommending going all in. Tobin suggests microcaps should make up no more than 5 per cent of the equity portion of a well-diversified portfolio. And this is also not a part of the market where investors can take a passive approach – it is structurally impossible and a function of the liquidity issue raised by Buffett.
“If an ETF was to attract a billion dollars in assets, then immediately, you can’t really invest in microcaps,” says Tobin. “The ETF would end up owning 15 per cent of nearly every company in the index.”
This leaves investors with two realistic choices: pick your own stocks or back an active manager. DIY investors should focus on more straightforward businesses, says Tobin, which often means consumer-facing stocks they can interact with. But sectors such as mining and materials – which account for nearly half of all microcaps – and biotechnology require specialist knowledge to interpret drilling results or clinical trial data, for example – plus a lot of patience, which is something retail investors often lack, Tobin says.
Shaun Weick, a deputy portfolio manager at Wilson Asset Management, approaches the microcap universe with the same method suggested by Buffett and Tobin – “good old-fashioned reading”.
“Roll up the sleeves and look at some presentations and reports,” he says. “There’s a lot of undiscovered gems down there.”
3. Back growth that leads to profit
The prize in microcap investing is finding a company that can graduate to become a small-cap or a mid-cap. Profitable microcaps are rare. Those that pay dividends are even rarer, so investors often focus first on revenue.
“We want strong revenue growth that eventually flows through to profit,” says Weick, noting that market darling Life360, which provides location-sharing and safety services for families, is a textbook case. Life360 listed as a microcap, delivered strong top-line growth, held costs stable and eventually tipped into free cash flow. Today it is worth $9.4 billion.
Another key criterion is the size and growth potential of the market in which a company operates, also known as the total addressable market. “There are a lot of value traps in microcaps where there’s just no more market to grow into, or there are too many headwinds in the market, so you’re never going to see a revaluation,” Weick says.
He says healthcare giant CSL, which listed in 1994 with a $300 million market cap, and healthcare imaging software group Pro Medicus, which listed in 2000 with a $115 million capitalisation, are rare examples of former microcap stocks that rose to the ASX 50. Their success was in part because their products could scale into the enormous US healthcare market.
But even reaching the ASX 300 is significant because it triggers passive fund inflows and institutional interest, boosting demand for the stock. Other well-known examples include Domino’s Pizza Enterprises, Mineral Resources and Afterpay, now part of Block.
It is worth noting that while these companies started small, their initial market caps have not been adjusted for inflation – some would have been considered small caps in real terms.
4. Beware of pretenders
For every winner, many more companies never break out. Tobin warns against companies that have been listed for decades without a significant change in market cap. “If it IPOed in ’98 and it’s still capped at $60 million, you have to ask why that is,” he says.
Cash burn is another danger. An unprofitable company needs to keep an eye on cash in the bank and raise capital before it is under serious pressure. For example, if a business is burning $1 million per quarter and only has $5 million in the bank, it will need to raise capital within 12 to 15 months just to stay afloat. But when a company sells new shares, it usually does so at a discount to the current price, reducing potential capital gains and diluting the holdings of existing shareholders. That’s a calculation retail investors often fail to make, says Tobin.
Weick emphasises management quality. His team meets with hundreds of company executives each year, including the second-tier managers such as heads of sales, to gauge a business’s prospects. A track record of delivery and strong insider ownership are also positive signals.
Red flags to watch out for include CEOs who move from company to company without delivering results, excessive stock-based compensation that dilutes shareholders, and frequent auditor changes. “If it’s [an audit firm] you’ve never heard of, you’ve got to raise your eyebrows,” Weick says.
Even if the fundamentals look sound, structural challenges such as volatility and liquidity remain a risk for investors at the small end of town. Valuing loss-making companies is also difficult.
St John takes a conservative, iterative approach and builds growth forecasts using both statistical data and industry-level insights – but a compelling story that captures investor imagination is also important in this space.
What the experts are watching
So how do these four lessons translate into actual opportunities? We asked our four experts for their top microcap picks.
Tobin has listed three microcaps he’s bullish on. The first is micro-investing app Raiz Invest, which has a market cap of $67 million. “Raiz has now reached critical mass in the Australian market, with multiple growth options available to drive sustained profitability over the medium term. The stock also looks undervalued compared to recent transactions in the sector.”
A second pick is consumer insights platform Pureprofile, with a market cap of $44 million. “PPL’s current management took over a deeply underperforming and loss-making business just over five years ago and has executed a highly commendable turnaround, resulting in the company now being profitable with strong growth coming from its international and platform businesses,” Tobin says.
His final pick is respiratory equipment manufacturer Cleanspace with a market cap of $63 million. “CSX is another business transitioning from a loss-making to a profitable one, with good growth across all its geographies and divisions. Its razor and razor blade style business model is attractive in the specialised industrial products it sells.”
Ivers likes gym network Viva Leisure, which has a market cap of $155 million and is known for its largest brand, Club Lime. The portfolio manager says the focus has shifted from network growth to financial returns, with dividends likely in one to two years. “Great growth, completely unloved, although the FY25 result has shown some really strong trends, so likely getting more attention.”
Weick’s pick is fintech lender Plenti, which has a $226 million market cap. “Management is excellent, has strong alignment and a large runway for growth, with valuation compelling. The recent productivity report recommendations could be a significant tailwind, too.”
St John’s pick is environmental engineering firm The Environmental Group, which has a market cap of $86 million. “EGL is a particularly interesting stock from a microcap perspective as it offers stable, recurring earnings alongside considerable growth potential.”
She says the business is “highly cash generative”.
“It has market-leading positions in its traditional business segments. Simultaneously, its more recent diversification into waste plant sales and PFAS treatment plants offers significant growth opportunities. Traction in both of these segments is continuing to accelerate and offers sizeable upside to current valuation.”
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