Small caps tipped for Australian market growth

Australian small caps have drawn attention from local analysts who see selective opportunities ahead despite a tough year for the segment.

VanEck warns of a turning market

VanEck senior portfolio manager Cameron McCormack noted that the small‑cap group fell more than 10 % this year while the broader S&P/ASX 200 rose 2.89 %. He said the current market gap could create openings if the cash rate stays near its peak.

“That is a painful gap but if the cash rate is at, or close to, its peak, small caps could be among the biggest beneficiaries,” he told investors.

He added that small‑cap firms are “highly sensitive to financing conditions and investor confidence,” meaning a modest shift in rate outlook could lift valuations and capital flows.

The comments came before the 29 July inflation release, which showed June’s headline rate easing to 3.8 %, potentially easing pressure on the Reserve Bank of Australia ahead of its next meeting.

McCormack cautioned against a blanket buying approach. “Around 60 % of the Small Ordinaries Index is allocated to companies with negative earnings. A broad index approach means owning all of them, including businesses that remain dependent on expensive external capital to survive or grow,” he said.

VanEck therefore favors a growth‑at‑a‑reasonable‑price (GARP) strategy for Australian small caps, looking for firms that combine earnings growth with sensible valuations.

He highlighted engineering services firms Tasmea and SRG Global as examples. Tasmea’s shares have risen about 140 % over the past year, while SRG Global is up roughly 110 %.

“Companies such as Tasmea and SRG Global are already demonstrating that businesses with recurring revenues, essential‑service exposure and disciplined capital allocation can continue growing despite restrictive conditions. That is where we believe the real opportunity lies,” he said.

Datt Capital stresses cash‑flow focus

Datt Capital chief investment officer Emmanuel Datt echoed a similar theme in a recent note. “Our clear bias for FY2027 is owning cash flow, not hope. We want exposure to companies that are resilient and well‑priced, where we can benefit from the economics in the present, not in a speculative future,” he wrote.

He described the macro backdrop as “stagflation light,” a mix of higher inflation, rising unemployment and slowing growth alongside energy constraints. In that setting, selectivity, cash‑flow certainty and pricing power should be rewarded.

“Against this scenario, we are pursuing opportunities which are a combination of energy exposure, small‑cap selectivity and cash‑flow discipline,” Datt added.

The valuation discount for small caps has widened back to about 20 % after briefly converging with large caps through late 2025, a shift driven by geopolitical disruptions since March.

“Improving fundamentals, AI productivity tailwinds, and modest cost‑out potential create a disproportionate earnings swing for small businesses relative to the valuation being paid,” he said.

Like VanEck, Datt also sees GARP as an attractive style, citing larger‑cap names such as Hub24 and Netwealth, which trade at notable discounts.

He mentioned discretionary retail exposure ahead of the Christmas trading peak, noting that some of those stocks are modestly priced relative to their 52‑week lows and positioned for higher short‑term sector volatility.

The retail outlook follows Myer’s recent trading update, which described “sustained cost‑of‑living pressures driving consumer sentiment to its lowest levels in recent times.”

Ultimately, Datt concluded that while the firm favors small caps, the current climate does not reward passive or undifferentiated exposures.

“Narrow market breadth, concentrated sector leadership and macro conditions that penalise duration and low cash flow businesses all point toward the same conclusion that where capital is allocated matters more than how much is allocated.”

Given the mixed signals, investors may find it prudent to focus on firms that have demonstrated resilience through recurring revenues and disciplined capital use, rather than chasing broad index returns that include many loss‑making companies.