Small cap stocks are generally associated with high risk. This...

Small cap stocks are generally associated with high risk. This perception, partly a result of the speculative ventures to which many investors are attracted, is not entirely valid when you consider that small companies can enjoy growth potential in even the most difficult market conditions and, due to the lack of research about them, tend to trade at a discount to valuation.

When compared to any index of larger capitalisation stocks, small caps also tend to deviate from the trend, adding to the perception of risk. But considering my pessimism about the Australian index as a whole, I?m not too concerned if small caps don?t follow the index (see Look beyond the ASX 200).

In the second half of last year, I researched a series of small-cap companies that, on average, outperformed the All Ordinaries index by three times during the period (see Under the Radar: Over the benchmark)

There?s always an element of luck in such an outcome, but the fundamental criteria were that all of these companies were solid business models with strong growth potential or an equally attractive value proposition.

I?ve used the same basic approach again and spoken to a handful of small-cap specialists to create a list of a dozen stocks in mid-2011 that I believe have a similar potential for outperformance in what are otherwise tough trading times.

I?ve looked at some of these companies before, while others are new. Either way, if taken as an aggregate over the past year, we can see that this diminutive dozen already would have already done quite well against the benchmark.
It?s looking-forward, however, where this group of companies could be best positioned, when viewed against the risks facing Australia and the world at large (see A world of worry). They may not be immune against tomorrow?s apparent rapture or, more prosaically, swings in price experienced by any relatively illiquid financial instrument, but in the long term I believe they have strong potential.

Keep holding M2 end year results not to far away and I expect as usual M2 will deliver better than predicted.

Sd