What are ASX small-cap shares?
A small-cap stock typically has a market capitalisation ranging from a few hundred million up to $2 billion. The benchmark for ASX small caps is the S&P/ASX Small Ordinaries Index (ASX: XSO). It represents 200 companies ranked 101-300 in the S&P/ASX 300 Index (ASX: XKO).
Analysts and the media typically cover large-cap shares more vigorously than small caps, which are generally not household names. They may be too small for mutual funds to invest in, as many managers won’t buy into a company until its market capitalisation reaches a minimum level. The lack of institutional investors means small-cap shares are often overlooked.
Why invest in them?
Small-cap shares are potentially the large-cap shares of the future. Generally younger companies than those in the S&P/ASX 100 Index (ASX: XTO), small-cap companies may have greater growth prospects than their larger peers. Nonetheless, small-cap shares also tend to be more volatile than larger-cap stocks, meaning share prices can fluctuate more.
Most of the approximately 2,000 companies listed on the ASX are small-cap businesses. Small-cap shares can have significant growth potential, which larger companies generally can’t match. This means they have the potential to deliver significantly higher share price appreciation than large caps.
Below, are three top small-cap shares ranked by market capitalisation from high to low.
Top small-cap stocks on the ASX
| Company | Description |
| NIB Holdings Limited (ASX: NHF) | A health and travel insurance provider giving cover to more than 1.5 million Australian and New Zealand residents |
| TechnologyOne Ltd (ASX: TNE) | An enterprise software company that provides a software-as-a-service (SaaS) business resource planning solution |
| Chorus Ltd (ASX: CNU) | New Zealand’s largest telecommunications infrastructure company |
NIB Holdings
This company is Australia’s third-largest travel insurer and a global travel insurance distributor. NIB Holdings provides insurance coverage to more than 1.5 million Australian and New Zealand residents. It also covers more than 180,000 international students and workers in Australia.
In late 2022, NIB raised $150 million to fund its entry into National Disability Insurance Scheme (NDIS) Plan Management. Plan managers are providers that support recipients of NDIS funding to manage their funding. NIB plans to enter the market via acquisitions, commencing with the purchase of Maple Plan. Maple Plan is a plan manager serving a base of about 7,000 participants.
TechnologyOne
With a 35-year history, TechnologyOne is Australia’s largest enterprise software company. It provides a global software-as-a-service (SaaS) enterprise resource planning solution which is available on any device, anywhere, at any time. The company provides enterprise software that evolves and adapts to new and emerging technologies. More than 1,200 corporations, government agencies, local councils, and universities use its software.
In FY22, TechnologyOne announced its 13th consecutive year of record profit, revenue, and SaaS fees. With the SaaS business growing faster than expected, TechnologyOne is on track to surpass its target of more than $500 million in ARR by FY26.
The company now has subscriptions from more than 800 large-scale enterprise organisations, with millions of users leveraging its software for mission-critical activities. This makes TechnologyOne the most significant single-instance SaaS enterprise resource planning (ERP) offering in Australia.
It is a leading provider to the local government sector, with more than 320 council customers in the Asia-Pacific region (APAC). It also performs strongly in the higher education sector, closing 10 major deals in FY22.
Chorus
This is New Zealand’s largest telecommunications infrastructure company. Chorus builds and maintains a network of predominantly local telephone exchanges, cabinets, and copper and fibre cables. Tracing its origins to the formation of the New Zealand Post Telegraph Department in 1881, Chorus was formed in 2008 to give all service providers access to the local fixed line network.
The company reported a solid performance in FY22, with a net profit after tax (NPAT) of $64 million. Underlying revenue was $959 million, driven by continued strong growth in demand for fibre broadband. Careful cost management partly mitigated inflationary and COVID pressures. The strong result has enabled Chorus to return to earning more than it is investing in the network for the first time in a decade. This facilitated a dividend of 35 cents for FY22 and increased dividend guidance for FY23 and FY24.
What to look for when investing in small-cap shares
As companies mature, earnings need to grow so they become profitable. Small-cap stocks may not yet be profitable, but ideally, losses should be narrowing. Many investors use the price-to-earnings (P/E) ratio to indicate whether a stock may be over or undervalued.
Finally, for a company to grow, a good market for its products and services must exist. A larger market means there are more opportunities to generate revenue.
Pros of investing in small-cap shares
Growth potential: The law of large numbers makes it more difficult for companies to grow as they become bigger. This means small companies have, by definition, greater growth potential than large-cap companies.
Capital gains: Small-cap shares that graduate to large-cap shares can deliver investors returns in many multiples.
And the cons
Volatility: The share price of small-cap shares can fluctuate to a greater extent than that of large-cap shares during market upturns and downturns.
Risk: Investing in smaller companies can be higher risk as their balance sheets are not as strong as those of larger companies, and they may not have access to the same lending.
Are ASX small-cap stocks a good investment?
Whether ASX small-cap stocks are a good investment for you will depend on your financial situation and investing goals. Small-cap shares have the potential to deliver outsized returns, but higher potential rewards come with a heightened degree of risk.
A small-cap company will have a different level of capital than mid-cap stocks and large-cap stocks. This means their financial resources to keep the company running and growing are more limited, leaving them more vulnerable to failure.
Small-cap shares also tend to be less liquid than larger-cap shares, meaning it may take more time to sell them at a price that reflects their value. Nonetheless, their potential for outperformance means small-cap shares can help boost returns in a well-diversified portfolio.