Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 310

WAAAX and an extraordinary disconnect

When assessing the current landscape of the ASX, there has been a significant shift of investor dollars towards a highly select group of companies. Much has been made in the headlines about the WAAAX stocks (Wisetech, Altium, Afterpay, Appen and Xero). The share price performance of these companies has been exceptional, and in our opinion an element of FOMO (fear of missing out) has driven valuations to multiples much higher than their comparable global peers.

Impact of WAAAX moves

The demand for the WAAAX businesses has produced what we believe to be a disconnect between price and value that has developed over the past two-plus years. This disconnect exists between micro-caps and the wider market.

For the purpose of this article, we define a micro-cap as a company with a market capitalisation of less than $300 million. To illustrate, we have separated the domestic market (ex-resources) into two groups in 2019 to date: those with a market capitalisation above $300 million, and those below.

The chart below shows that since the recent lows of December 2018, companies with a market cap of less than $300 million have returned approximately 4.6%, whereas companies with a market cap of greater than $300 million returned almost 17%. It's an extraordinary difference.

Source: Bloomberg

The reality of micro-cap investing

Micro-cap investing is not suited to all. It is a much more inefficient part of the market that takes patience and tolerance to navigate successfully. In our experience, the growth and development of companies generally takes longer than originally anticipated. When a company achieves certain milestones or hits its targets, often it is not immediately reflected in the share price. There are also many other factors to consider such as liquidity, management expertise, capital requirements and investment time horizon, all of which require significant analysis in an area of the market which is not widely covered by analysts.

Micro-cap investing can also be an opportunity to obtain a meaningful position in a high-quality company before share price growth occurs. The holy grail of investing is finding a company with quality fundamentals that is growing its earnings before the wider market discovers it. Whilst these earnings continue to grow, its trading multiple expands, meaning investors are willing to pay a higher price for shares in this company. Many of the best ASX companies start out as micro-caps and have made those patient investors fortunes along the way.

Why has the current micro-cap disconnect happened?

In our opinion, this trade-off between ‘reality’ and ‘opportunity’ in micro-cap investing creates an area of the market that is cyclical in the court of public opinion. Investing in listed micro-caps goes in and out of fashion based on how much emphasis investors are placing on each end of the reality/opportunity spectrum.

There have been recent examples of institutional investors losing mandates to invest in the micro-cap sector. When a mandate is lost, a fund must return the deployed funds in a timely manner to the relevant mandate provider (e.g. an industry fund, non-for profit, charity, organisation, university, family office). This can result in large scale selling which is not correlated to the fundamentals of the underlying company.

As a result, many retail investors follow suit by selling their shares as lower share prices often triggers further selling. Furthermore, leading into the end of a financial year, retail investors may look to manage their taxable income by undertaking tax-loss selling on those positions which have underperformed during the financial year to offset their gains. Share prices then fall further, this time on very low volumes.

This disconnect can become self-fulfilling. The result is an environment in micro-caps where liquidity, and particularly buying demand, disappears.

When does this disconnect end?

Whilst the current environment may not paint a rosy picture of micro-cap investing, we are firmly of the view that the public opinion pendulum will at some stage swing back to more normalised levels. Micro-cap investing will again come into vogue. When will this disconnect end? Just like everyone else, we do not know.

What gives us confidence in our investment approach is the principle that despite short term disconnects between price and value, over the long term, price should match value. This is particularly the case in micro-cap investing.

In his book ‘What Works on Wall Street’, Jim O’Shaughnessy analyses compound annual returns for a period of 50 years of US equities, segmented into the market capitalisation bucket. During this period, micro-cap stocks outperformed large cap stocks by on average close to 3% p.a. The power of compounding means such that a difference of circa 3% p.a. means an outsized return of over at the end of that 50 years. As Charlie Munger said:

“The big money is not in the buying or the selling, but in the waiting.”

We believe this current period of disconnect for ASX micro-caps has further widened the inefficient playing field that is micro-cap investing. During this period of ‘waiting’, we can increase ownership of quality businesses at low prices and also revisit companies we know well that have seen an earnings multiple reduction. Some have seen earnings multiples reduce for legitimate reasons that may be only short-term headwinds, others for reasons less relevant to the business fundamentals such as mandate or tax-loss selling. These are the opportunities we like to see when making new long-term investments.

For those willing to spend the time doing the work on micro-caps, we believe there are compelling risk-adjusted returns on offer.

 

Robert Miller is a Portfolio Manager at NAOS Asset Management, a specialist fund manager of three listed investment companies (LICs) with concentrated exposures to Australian listed industrial companies outside of the ASX-50, and a sponsor of Cuffelinks. NAOS' LICs are in micro-cap stocks (ASX:NCC), small-caps (ASX:NSC) and mid-caps (ASX:NAC).

This content is for general information only and must not be construed as investment advice. It does not take into account the investment objectives of any particular investor. Before making an investment decision, investors should consider obtaining professional investment advice.

For more articles and papers from NAOS, please click here.

 

  •   13 June 2019
  • 3
  •      
  •   

RELATED ARTICLES

It’s the large stocks driving fund misery

Get me out of Australia?

Why August company reporting season was poor

banner

Most viewed in recent weeks

Why spending more in early retirement can improve lifetime income

Conventional wisdom encourages retirees to preserve superannuation. But if those likely to qualify for the Age Pension later in life spend a little more today, it may deliver higher lifetime income and a more stable retirement.

Testamentary trusts have secured the CGT exemption

Treasury’s latest CGT reform draft delivers a win for testamentary trusts and deceased estates, exempting estate-derived gains from the 30% floor. However, questions on death and divorce rollovers remain unresolved.

Meg on SMSFs: What do we think about reversionary pensions these days?

Reversionary pensions have long been a staple of SMSF estate planning, but are they still the best option? Meg Heffron revisits a once-clear favourite and asks whether changing super rules have shifted the balance.

Is it time to bail on Australian stocks?

For generations, Australian investors have backed banks, miners and dividends. But has that loyalty come at a cost? A look at the numbers raises an uncomfortable question about where future returns will come from.

How does the 4% rule stack up?

The 4% rule has long been retirement's gold standard. But after a difficult period for investors, fresh analysis suggests a more conservative approach may significantly improve the chances of making savings last.

Testamentary trusts survived the trust tax. The drafting battle has just begun.

The fight over testamentary trusts looked settled. Then the draft legislation arrived. Hidden in a technical detail is a question that could force many families to rethink wills they thought were already future-proof.

Latest Updates

Planning

How the typical Australian Family could save $844,350 in taxes

The value of a testamentary trust is not determined by wealth alone. Depending on circumstances, it can reduce the tax burden on inherited income, create efficiencies and help build intergenerational wealth.

Superannuation

There's a reason why your super is locked up until your 60s

For decades, it seemed settled. Then one controversial idea reignited a debate that could reshape the financial future of millions. The real question isn’t who’s right or wrong, but whether a long-held assumption deserves another look.

Property

The housing slide could become a crash

House prices are sliding across Australia, yet the most dangerous ingredient for a housing crash is still missing. If job losses surge amid growing economic risks, today's correction could become a historic property downturn.

Retirement

Under-retiring: The greatest retirement risk in a generation

Two retirees. Similar savings. Completely different lives. New research from Challenger reveals why some Australians confidently spend in retirement while others hold back and the overlooked factor shaping retirement decisions.

Five risks to watch in markets

Things you may often hear are: a recession is around the corner, markets are overpriced, the AI sector is about to flop at any moment. It’s like the never-ending laundry pile that sits in my house, it never really disappears.

Investment strategies

Do you qualify as ‘rich’?

What does it mean to be 'rich'? For something so universally desired, it is surprisingly difficult to define. That ambiguity creates a challenge for investors and raises a bigger question about what financial success really looks like.

Investment strategies

If you’re worried about your bond portfolio, you’re missing the point

Most investors think they know what bonds are for. But when markets turn volatile, a surprising misunderstanding can lead to costly decisions. Here’s the overlooked lesson that could change how you view your portfolio.

Alliances

  • ASA-Logo-RGB-ActiveGreen-web.png

© 2026 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.