Analysts' IntelligenceSMSF Strategies

Emerging company options

7 Oct 2021 13 day(s) ago

Diversifying into smaller companies can be  a sound strategy, but the risk-reward equation tends to be different.

Emerging companies can produce high returns but of course tend to have higher levels of risk. They also tend to pay less dividends than established companies because they are more likely to be reinvesting their profits rather than farming them out to investors. So the focus tends to be on capital gains, share price growth, rather than income.

One approach to that level of the market is to invest in small cap indexes. The ASX Small Caps index has grown by about 35% over the last five years and by about 17% over the last year. In what has been a stressed environment because of the 'pandemic' there is certainly an argument that this represents a sound option for diversification.

Here is the one year performance of the ASX Small Caps:

Another way is to invest in the companies directly. Jarden, which covers some of the emerging companies space, notes that the recent reporting season contained limited surprises across its Emerging Companies coverage, with an average revenue deviation of less than 1% against forecasts and trading updates largely in line with what was expected. Given the uncertain economic conditions that is a good performance.

Jarden says that online retail has been a beneficiary of the ‘pandemic.’ A key observation has been the divergence between businesses that have emerged from this extraordinary period with an enhanced business model and market position and those that have emerged with some short-term benefits and longer term challenges.

"We see the following four stocks as long-term winners:

ABY (Adore Beauty Group). Buy, target price $5.70: The FY21 results demonstrated that ABY was benefiting from COVID. However, we believe a structural shift is underway and online penetration will continue to increase. With the introduction of private label skincare and haircare, coupled with reinvestment in the business until FY24E, we believe ABY will continue to drive double-digit top line growth and achieve operating leverage from FY25E.

ADH (Adairs) Buy, target price $5.13: We expect ADH to be a net beneficiary of the reopening of retail post lockdowns, as 40% of store trading returns and it has been resilient, with sales +5% in the first 7 weeks of FY22 (excluding store closures) supported by online sales growth of +13-16% while cycling strong comps.

CCX (City Chic Collective) Overweight, target price %6.72: The results highlighted a key inflection point in its offshore growth strategy, with the traction achieved in the US surprising us. We have increased confidence in the opportunity and believe CCX has a very attractive model for pursuing that growth.

TPW (Temple and Webster) Overweight, target price $15.81: TPW’s trading over the Sep-21 quarter has demonstrated that its operating momentum, while clearly a beneficiary of COVID conditions, is also reflective of some very strong structural trends within its category. We believe the business is very well placed to drive its competitive position further over the coming 12 months and to continue delivering strong sales results."


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