Why ex-20 is the prime hunting ground for ASX returns

Of the top 20 largest and most successful US companies from the past quarter century, only three remain constituents today – Walmart, Exxon Mobil and JP Morgan Chase.

Of the top 20 largest and most successful Australian companies from 2000, more than half remain as constituents, with banks and miners dominating.

While our biggest companies have served us well, the lack of innovation and new entrants into the upper echelons leaves the top part of our market looking old hat compared to global peers, lacking diversification and growth potential.

Fortunately, looking outside the top 20 yields a different result. The small and mid-cap space is rich with companies on the cutting edge, disrupting industries and carving out new markets. But there are also greater risks.

So, how are investors to sort the wheat from the chaff? To find out, Livewire’s Vishal Teckchandani is joined by Marcus Burns from Spheria Asset Management and David Allingham from Eley Griffiths Group.

They share what they look for in small and mid-caps (SMID) and, for good measure, they highlight a favourite SMID they believe has staying power. 

This video was filmed on 26 March 2025. 

Edited Transcript

Vishal Teckchandani: Welcome to Buy Hold Sell, brought to you by Livewire Markets. My name is Vishal Teckchandani. If you think about the top American companies, there have been so many changes in the past two decades, especially among large caps. Within the ASX 20, not so much, and that should raise concerns about growth and diversification within the ASX large cap space. That's why in this episode we are going to go hunting outside the ASX20, and I've got two gentlemen to give me their playbook on how they find opportunities in Australian small and mid-caps. Welcome, Marcus Burns from Spheria. How are you?

Marcus Burns: Very well. Thank you.

Vishal Teckchandani: That's good. And David Allingham from Eley Griffiths.

David Allingham: Vishal, nice to see you.

Hunting beyond the ASX20

Vishal Teckchandani: Nice to see you as well. All right, David, I'll kick off with you. Why don't we bring it back to the basics? The principles of looking outside the X20. I understand you've done a lot of work on this ahead of the launch of your newest fund. Can you share?

David Allingham: Absolutely. We've got a 20-year heritage of investing in small caps, and it's a great part of the market for stock selection. The real attraction for mid-caps is the beta, or the market return. If you look at the ASX 50 to 100, that 50 stocks is the highest performing part of the Australian market over the last 20 to 25 years. So you're starting with a very strong market beta. But I think what's important is you can still complement that with the great alpha potential or stock-picking potential.

The other attributes that are great about mid-caps is you've got diversity by sector, so you've still got resources, you've got reach, it's diverse and you haven't got one stock or two that dominate the benchmark. So you've got diversity from a stock-specific standpoint as well. So it's really primed for great active management. And who wouldn't love sitting around working on the growth potential of Realestate.com (ASX: REA) and Technology One (ASX: TNE) and these great companies that have graduated into mid-caps? So we're really enjoying it.

Vishal Teckchandani: Okay. Strong beta, alpha potential, and diversification. Marcus, same views?

Marcus Burns: Yeah. Like he said. It's hard to do much more than that. I guess the other thing is there's so many stocks listed in Australia outside the top 20. There's 2,500 names, roughly, in Australia and New Zealand. So obviously, excluding the top 20, there's 2,500-odd left to pick and choose from, and quite a few of those are early stage and not making money. But even if you do a screen for stocks that make money in that universe, there's still roughly 550 names. So there's a lot of stock-picking potential within that. Like David, we spend a lot of time looking through that, sifting through it. There's poor coverage there, and that gives you a lot of opportunity, I think, to actually add alpha as an investor. And so that diversification, that diversity of opportunity set really creates a lot of potential value for investors.

Key factors for ex-20 companies

Vishal Teckchandani: Okay. So like you've both mentioned, there is an active management component to this. You are straying outside the large cap sphere. So talk to us about your playbook, Marcus. What do you look for in ex-20 companies?

Marcus Burns:

Yeah. We look for the same thing everywhere, whether we're buying micros, smalls, or mid-cap names. And really there's three foundations of how we think about investing. And they're not rocket science, but we look for free cash flow businesses; so businesses that are making earnings and actually turning that into cash. We look for good balance sheets. We like low risk companies. Preferably net cash balance sheets, so ones that are modestly geared. And then we still think the valuations matter. We run a ruler across all the names looking at all the ratios people would expect like PE ratio, EBIDTA, EBID. We do our DCF long-term and try to summarise that into a sense of value. And so if we can get those three things, whether it be a large cap, mid-cap, or small cap, we think they are the bedrock of good investment.

Vishal Teckchandani: Okay. David, turning to you. Cash flows, balance sheets. What do you look for?

David Allingham: All makes a lot of sense. I'd just add, in mid-caps, if you look back at the attributes of the stocks that have done particularly well in mid-caps, it's often stocks that are well-established. We understand their industry structure, their addressable market, and we can see that they're gaining market share. I think that's the key. If you look at a stocks like a Pro Medicus (ASX: PME), if you look at stocks like Technology One, if you look at REA, Carsales (ASX: CAR), these names that have come through, and actually now are often in the ASX 50. They've got clear addressable markets, they've got sound industry structures, and you can actually look at their market share gains. And I think the market really rewards that market share gain perspective.

Founder-led vs agency CEOs

Vishal Teckchandani: Okay. So it's not only about good companies but it's about that total addressable market. And I guess another important element of these companies is leadership. And you've got different types of CEOs. They can be founder-led, they can be agency-led, can be promoted from within. Is there a preference you have for one over the other?

David Allingham: I think the default for most active managers would be to have a founder-led business. I think that makes us feel good around the alignment and with the culture and the history of the founders starting there, still running the business. I think personally I'm a little bit more ambivalent. I think there is some exceptional agency-style CEOs, and I can rattle names off my head, but someone like a Vik Bansal probably would be one of our favourite company CEOs. So, I think also what it comes back to from us is really understanding the board. I think the board needs to hold management accountable. And that can be a founder or it can be an agency-style of CEO. And I think that we spend a lot of time understanding that board and management dynamic, and that's just as important to us.

Vishal Teckchandani: Okay. Marcus, do you agree with that?

Marcus Burns: I broadly do, actually. I think there's a lot of emphasis put on founder-led CEOs being better in some ways. And I think what's good about founders is they're connected. There's an ownership profile. There's real buy-in, effectively, but there's also some problems with founders. There's a few high-profile mid-cap names right now that have got real governance problems because of founders. And I think that's an issue that you have to counterbalance. And so you're looking for a CEO or a management team that have really bought in, either own lot of stock or act like owners. And there are plenty of cases where CEOs, founders have actually resigned and stocks have done really well post-their leadership. So I think it's pretty mixed, to be honest with you.

Stock picks

Vishal Teckchandani: Okay. Let's talk stocks. What is one small or mid-cap company on the ASX that you're excited about? So excited about it that you think it could be headed to the ASX 20 and become a large cap one day?

Technology One (ASX: TNE)

Marcus Burns: This is actually a tougher question than might meet the eye because the top 20 would be a market cap around about $30 billion. And so you're looking at stocks obviously outside that that could grow into that. I'll pick one, which is TechnologyOne. It's a tech name that does ERP software for universities and other clients. Very sticky client base. Market cap's currently about $9.5 billion, so it's got a long way to go to become a top-20 name but it is growing earnings around 15% to 20% a year backed by cash flows. And so over three to five years, maybe on the five-year time horizon, it could potentially get up into that top 20, or close to it. So that'd be my pick.

Vishal Teckchandani: Okay. TechnologyOne. He's picked a stock in one of the hottest sectors in the market. David, you've got something else for me?

SGH Limited (ASX: SGH)

David Allingham: We also like Technology One. It's been a great business and a great little small cap that's really made it all the way through. Look, I'd call that Seven Group Holdings, or SGH. Again, that's interesting. Both companies were kind of founder-lead. TechOne's transitioned really well into an agency CEO model. But in the case of Seven Group, I think you're dealing with a company that has really two of Australia's best industrial businesses. WesTrac, particularly their Caterpillar franchise in WA. And equally, Boral, which is a very strategic business, primarily on the east coast. But it's the cash generation of those businesses and it's the actual capital allocation capability of the management team. Ryan Stokes and Richard Richards have really proven an ability to not only make acquisitions well, and Boral being the best example, but also divest assets like the WesTrac China business or the franchise they sold, which they redeployed back into Coates Hire domestically. So we see this story. It's a $20 billion market cap. It's very reasonably priced today. It's got a conglomerate-style multiple to it, but over the very long term we do see this market cap growing and becoming larger, more liquid.

And we do think they've got balance sheet flexibility to do more M&A and add a third or a fourth industrial segment to their overall business.

Vishal Teckchandani: And there you have it, a playbook on how to identify opportunities in the ex-20 and a couple of worthy names that could ascend into the ASX large cap space. I hope you enjoyed this video. My name is Vishal Teckchandani. Don't forget to this video and subscribe to our channel. Happy ex-20 hunting.