Smallcap stocks will rule 2024, National Bank says

It was a year that the term “Magnificent Seven” was popularized and indeed, 2023 was a year of concentration in market gains.

But 2024 is a year in which the wealth will be shared more evenly, say analysts at National Bank Financial.

In a comprehensive report containing their thoughts on the year that was and the year that will be, analysts Richard Tse and John Shao said the emergence of smallcaps will be consistent theme in 2024.

“We can’t really talk about our coverage universe without discussing US Technology given that market leads the broader group/market,” the pair said. “When looking at that, US Technology was driven by the “Magnificent 7” (2023 market cap. weighted return +90%). That said, there was a widening of breadth in late 2023. With respect to the broad indices, the S&P Info Tech index (ex. APPL, MSFT, and NVDA), BVP Emerging Cloud Index and S&P/TSX Info Tech Index were up 48%, 40% and 69%, respectively, vs. the S&P 500 index up 24%. In our view, that outperformance was driven by a flight to “quality”, a reversion from an “oversold” 2022, AI hype, and recognition and action towards capital allocation discipline from the days of “growth at all cost”.

“While returns in Technology were more evenly distributed relative to the S&P 500 index (+24% in 2023), we believe the volatile rate environment drove a flight to perceived relative “quality” in large cap technology where scale, outsized relative growth, robust balance sheets / strong cash flow generation, and profitable became a place to hide. That was more than apparent when looking at the magnitude of returns for the larger names with the upper quintile (> $155.7B market cap.) relative to the lowest quintile (< $18.0B market cap.) in the S&P Info Tech index.”

The analysts say that on a relative basis, the same thing happened in Canada, with larger tech stocks performing better than smaller ones in 2023.

“Despite the absence of Megacap Tech names in Canada, that flight to “quality” also happened here where the top 10 largest Tech companies returned an average of 48% in 2023 with outliers being Nuvei and Kinaxis. For Nuvei, it was negatively impacted by a shift in industry dynamics across the Payments space. For Kinaxis, we think it had to do more with the fact that it held up better than the group in 2022 which meant it had less to recover given an already robust valuation on a relative basis.”

Tse and Shao say investors should be looking squarely at smallcaps if they want to continue the performance that they got in 2023.

“We think the outsized relative underperformance of smaller cap names has presented an opportunity for a “catch up” trade in small-mid cap tech names in 2024, they wrote. “At the same time; profitability expectations are improving. Take for example the Bessemer Venture Partners Emerging Cloud Index, a proxy for high growth Tech companies (mostly mid-to-small cap names), shows profitability expectations have been revised upwards significantly; yet, the valuation gap as noted above is below that of its larger cap peers. In our view, there are many smaller Tech names (particularly our NBF coverage list) having potential for margin expansion and accelerated growth over the next 12 months.

The pair listed their best Canadian smallcap and midcap tech ideas. They are Coveo (Coveo Stock Quote, Chart, News, Analysts, Financials TSX:CVO), Real Matters (Real Matters Stock Quote, Chart, News, Analysts, Financials TSX:REAL), Tecsys (Tecsys Stock Quote, Chart, News, Analysts, Financials TSX:TCS), and Thinkific (Thinkific Stock Quote, Chart, News, Analysts, Financials TSX:THNC).