Standout stocks in a discounted part of the market

Heading into reporting season, the market looked expensive on the surface - trading around 18 times forward earnings - but if you dig a little deeper, there are still pockets of real value.

One of the most compelling areas is small caps.

Over the past three years, small caps have underperformed mid and large caps, breaking from historical trends. Typically, they trade at a premium to the broader market. Right now, they’re at a discount. And with earnings growth forecasts nearly double that of large caps, this is shaping up to be one of the best opportunities we’ve seen in a long time.

Reporting season is always an exciting time for stock pickers. It’s when we get real results, cut through the noise, and see whether our investment theses hold up. This season was the most volatile I’ve seen in over 30 reporting periods - but with volatility comes opportunity. And we made the most of it.

Here are some of the key takeaways from this reporting season:

1. Small caps are trading at a discount – Historically, small caps trade at a premium to the broader market because they offer higher growth potential. Right now, they’re trading at a rare discount. This is a major signal that the market isn’t pricing in their earnings potential, creating a strong setup for long-term investors willing to back quality companies.
   
2. Gold stocks are deeply undervalued – Despite record-high gold prices in Australian dollars, many gold stocks have failed to keep pace. Investors have been focused on cost pressures and operational challenges, but this has created a disconnect. If gold prices hold up, there’s a strong case for a re-rating in quality gold producers.
   
3. Volatility created opportunities – This reporting season saw some of the biggest share price swings in years. While this can be unsettling, it also presents opportunities. Stocks like Zip and Jumbo Interactive saw sharp moves that created attractive entry points for investors who could look past the noise and focus on fundamentals.
   
4. High-quality management teams are proving their worth – Companies with strong leadership and clear strategic execution are standing out. Those that can navigate rising costs, supply chain issues, and shifting consumer trends are being rewarded, while weaker operators are being punished. This is a stock picker’s market.
5. The Australian economy is muddling along – We’re not in a boom, but we’re not falling off a cliff either. The economy is holding up better than many feared, with businesses adapting to higher interest rates and cost pressures. Companies that can execute well in this environment are gaining market share and setting themselves up for strong returns when conditions improve.
   

At the end of the day, investing in small caps comes down to backing quality companies with strong growth prospects that are trading at a discount to intrinsic value. That’s exactly what we’re doing. History has shown that this approach delivers strong results over time.

Transcript

Heading into the reporting period, markets at face value appeared to be pretty expensive, trading on about 18 times forward earnings. That said, if you scratch beneath the surface, there are plenty of pockets of value out there, and one of those pockets is in small caps. The reason why there's value in small caps is because, over the past three years, the small-cap index has underperformed both the mid-cap and large-cap indices three years in a row.

Historically, the small-cap index has traded at about a 10% PE premium to the broader market. Because of that underperformance, it’s now trading at about a 5% discount to the broader market. As a starting point, small caps appear much more attractive than the broader market. In addition, the earnings forecast for the small-cap benchmark is twice that of the large-cap benchmark. Given the reasonable valuation levels and expected superior growth, small caps offer an attractive place to find value.

Reporting period is an exciting time for us. As stock pickers, it validates the work we've done leading into it. For most of the year, there is limited company-specific news, and markets tend to be pushed around by macroeconomic factors - things like Trump tweets or rumours about China’s economic stimulus. But for two months a year, companies report their earnings, and this is where our forecasting and valuation efforts are tested.

The Tyndall Small Cap Fund has been in operation for two years now, going through four reporting periods, and we have managed to outperform in all four. Having been in the markets for 20 years and experienced over 30 reporting seasons, I would say that the one we just had was the most volatile I have ever seen. This level of volatility presents opportunities.

An example of a stock we capitalised on during the reporting period was Zip (ASX: ZIP). Prior to reporting, Zip pre-released a snippet of its results, which caused market panic. The result itself was a slight miss - $5 million due to cost adjustments - yet the stock fell 30%, wiping out a billion dollars in market cap. We had been shareholders of Zip for 13 months, initially buying at $0.50. When the stock fell, we stepped in to buy more, as our conviction in the company remained strong. Zip’s U.S. business, which represents 70-80% of its value, continues to grow its top-line revenue by 40%. Buy-now-pay-later remains a structural growth story, and we saw a great opportunity to acquire one of Australia’s fastest-growing companies at less than 15 times forward cash EBITDA.

Another exciting position for us is Jumbo Interactive (ASX: JIN), a hidden gem in the consumer discretionary sector. Jumbo is the leading online reseller of lottery tickets, a highly resilient industry. Before reporting, we trimmed our position based on risk-reward assessment. The stock subsequently fell 13% intraday, allowing us to top up our position. The result showed management was executing well - they introduced a loyalty program that outperformed expectations and reallocated marketing spend to reactivate the customer base. With online lottery penetration at 40%, we see further growth potential.

One area where we see extreme value is in the gold sector, which represents 12% of our portfolio. Gold is trading at all-time highs in Australian dollar terms, yet gold stocks have lagged. The key reason is that, over the past couple of years, wage inflation and cost pressures impacted profitability. However, we are now seeing operating leverage come through, generating strong cash flows. Our exposure includes Tier-1 low-cost producers like Gold Road (ASX: GOR) and Capricorn Metals (ASX: CMM).

An interesting gold stock we own is Vault (ASX: VAU), which emerged from the merger of Red and Silver Lake. This created a churn event in the shareholder registry, causing its stock price to lag. Under the leadership of Luke Tonkin, a highly experienced executive, the company has delivered projects on time and on budget. As they continue executing, we believe the valuation gap between Bolt and its peers will close, presenting a strong opportunity.

A position where we gained confidence post-reporting was Aussie Broadband (ASX:ABB), a diversified telecommunications business. Their core business beat expectations, with 44,000 new connections, taking their total to 728,000 - almost 8% market share. They are successfully leveraging their brand, with 54% of customers now on 100 Mbps plans or higher. Given its strong industry positioning, share growth, improving returns on capital, and conservative balance sheet, we see continued upside.

We also took profits in Nanosonics (ASX: NAN), a med-tech company focused on ultrasound disinfectant technology. They delivered a strong result and upgraded revenue guidance to 11-14%, lifting their margin profile. We initially invested when the market didn’t fully recognize its earnings growth potential or its new product, Chorus. The result showed strong operating leverage and increased annuity revenue, driving a 30%+ share price gain. Given this, we trimmed our position but remain invested due to the company’s strong earnings growth, high margins, and net cash balance sheet.

Looking at the broader earnings outlook, the Australian economy appears to be muddling along. However, a key takeaway from this reporting period is that high-quality management teams have successfully navigated challenging conditions and have been rewarded by shareholders. A great example is MA Financial (ASX: MAF), led by two founder-CEOs. Over the past decade, they have diversified away from reliance on a single fund asset and built a robust platform for alternative investments. The market is beginning to recognize their ability to generate consistent inflows and compound earnings growth year after year.

This is a fantastic time to be looking at small caps. They have underperformed large caps over several years, are trading at attractive valuations, and have strong earnings growth potential. We are managing a portfolio of quality companies trading at a discount to intrinsic value, which has been shown to outperform over time.

Wrapping up this reporting period, a few key themes stand out. First, there are still plenty of pockets of value in the market. Second, the economy is muddling along. And third, backing quality management is critical - strong leadership will guide businesses successfully through economic cycles.

Managed Fund

Tyndall Australian Small Companies Fund

Australian Shares

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