ASX small-cap shares usually seem to me like much better long-term picks for wealth-building than ASX blue-chip shares.
The term blue chip describes the largest, most well-known and most financially secure businesses. In Australia, we’re talking about companies like National Australia Bank Ltd (ASX: NAB), Coles Group Ltd (ASX: COL), Telstra Group Ltd (ASX: TLS) and BHP Group Ltd (ASX: BHP).
Small caps are companies with a market capitalisation of less than $2 billion, though some people may say it’s when they’re smaller than $1 billion.
I’ll go through the two main reasons why I think ASX small-cap shares are more attractive to me.
Scalability
Smaller businesses typically have a much longer growth runway than larger companies because they are earlier on in their expansion.
It’s much easier for a business with a $500 million market cap to double it to $1 billion than it would be for a $50 billion company to grow to $100 billion.
Think about McDonald’s as an example. It would have been much easier to grow from 50 locations to 100 than it would have been to double from 5,000 to 10,000 locations. McDonald’s currently has over 38,000 locations – just adding another 5,000 outlets would be a mammoth task.
The amount of new loans that Commonwealth of Australia (ASX: CBA) would need to write to double in size is unfeasible in the medium term.
I think there are plenty of small-cap ASX shares that have demonstrated the potential for revenue and profit growth, such as Volpara Health Technologies Ltd (ASX: VHT) and Temple & Webster Group Ltd (ASX: TPW).
I’d rather most of my portfolio be invested in companies with good earnings and capital growth potential.
International diversification
Australia is a great place to do business. However, it’s only a small part of the global economy and has a relatively small population. There’s a big world of opportunity out there.
When we think about many of the big ASX blue chips, most earn a large amount of their revenue from Australia.
They’re missing out on great global opportunities to reach a bigger target audience, in my opinion.
Also, I believe it’s more likely that we can find businesses expanding overseas when we look at ASX small-cap shares. Names like Volpara, Siteminder Ltd (ASX: SDR), Life360 Inc (ASX: 360) and Frontier Digital Ventures Ltd (ASX: FDV) are all growing internationally.
Foolish takeaway
Of course, blue chip ASX shares may be able to provide more stability and peace of mind for some investors in a bear market. But, I believe that ASX small-cap shares will generate the strongest returns over the long term because of their small size advantage.
