5 of the top ASX small-cap stocks for investors to watch

What are small-cap stocks?

While they involve greater risk than their large-scale peers, small-cap stocks also bring the promise of more lucrative rewards given their higher growth potential as modest-sized companies.

A small-cap stock is generally defined as a company with a market capitalisation of between several hundred million to $2 billion.

As a result of this smaller size, they are often overlooked by both institutional and retail investors – especially given that players such as mutual funds will only invest in companies that have exceeded a certain market capitalisation threshold.

Small-cap stocks are also often overlooked by pundits and financial reporters, who prefer instead to focus on bigger companies with higher profiles and much larger market values.

Investors should still lend some attention to small-cap stocks, given their modest scale comes with potential advantages. By definition, they have far greater growth potential than large-scale companies that may have already maxed out in size. For this reason, small-cap stocks have the potential to deliver far greater capital gains.

Investors should also remain well aware, however, of the risks that accompany this greater growth potential. These include greater volatility during periods of market uncertainty and lower liquidity due to a smaller pool of interested buyers and sellers.

Smaller, fledgling companies can also be riskier investment propositions than larger companies, given they may not have established markets or access to favourable financing terms.

Despite the comparative lack of attention given to them, most of the roughly 2,000 companies that are listed on the ASX are categorised as small-cap shares. The benchmark indicator for the ASX small-cap share market is the S&P/ ASX Small Ordinaries Index (ASX: XSO), which is designed to measure companies included in the S7P/ASX 300 but not in the S&P/ASX 100.

The top 5 ASX-listed small-cap stocks to watch

Here is a list of five of the top ASX small-cap stocks to consider, for those investors who consider them an acceptable choice given their current risk/reward preferences.

1. Temple & Webster Group Ltd (ASX: TPW)

2. Kelsian Group Ltd (ASX: KLS)

3. Patriot Battery Metals (ASX: PMT)

4. Frontier Energy Limited (ASX: FHE)

5. Brainchip Holdings (ASX: BRN)

Temple & Webster Group Ltd (ASX: TPW)

Furniture and homeware retailer Temple & Webster Group Limited has leveraged a drop-shipping delivery model to bring products directly to the homes of customers, achieving 'faster delivery times and reducing the need to hold inventory.'

TPW bounced back from the impacts of the Covid pandemic in 2023 announcing in May that it had resumed year-on-year growth.

'In the face of turbulent macroeconomic conditions, it's incredibly satisfying to see Temple & Webster back in growth mode as we cycle out of periods impacted by COVID,' said CEO Mark Coulter. TPW said its cash position is strong, at $100 million with no debt.

Fund manager Wilson Asset Management is optimistic about TPW and expects it to gain market share, particularly given its investment in artificial intelligence to boost competitiveness.

The company posted record reuslts for the first half of FY24, with a 23% year-on-year rise in revenue to $254 million. According to Temple & Webster, this rise was driven by growth in repeat and first-time customers.

EBITDA for the period was $7.5 million, with a closing cash balance of $114 million and no debt as of the end of 2023.

Kelsian Group Ltd (ASX: KLS)

Public transit provider KLS-AU recently acquired All Aboard America, in a move that analysts have described as potentially transformational, granting the company access to the vast US market.

The company now has operations in Australia, Singapore, the UK and the US, covering the provision of charter services and transit services to clients from the government, corporate, education, LNG and tourism sectors.

Australian find manager IML is optimistic about the company, higlighting the potential for increased US earnings next year, making it one of the cheaper defensive and low risk growth stocks on offer.

Patriot Battery Minerals (ASX:PMT)

Patriot Battery Metals Inc is a Canada-based mining company that focuses on preious metals as well as materials used in electric batteries such as lithium. Its wholly owned Corvette Project in Quebec possesses considerable lithium potential, while Patriot also lays claim to a 40% stake in two other lithium assets.

Lithium demand could see long-term structural growth in future, due to the importance of the material in modern battery technology and the increasing adoption of electric vehicles globally.

For this reason a number of analysts are upbeat about Patriot, with the Wall Street Journal reporting that analyst consensus for the company shares is currently a buy.

Frontier Energy Limited (ASX: FHE)

Frontier Energy is another ASX-listed penny stock that could see its share price rise on mounting demand for clean energy alternatives. The company focuses on the generation of hydrogen as a fuel source using solar energy facilities, in a process dubbed 'green hydrogen.'

Frontier's flagship Bristol Springs project in Western Australia has potential hydrogen production of 4.4 million tonnes per annum at a cost of $2.83 per kilogram, according to a pre-feasibility study conducted in 2022.

Frontier also enjoys baacking from Western Australia's state government, which issued a statement of support for Bristol Springs after the company entered a binding agreement with Water Corporation to secure water for the project in March 2023.

Brainchip Holdings: (ASX: BRN)

BrainChip Holdings Limited is an artificial intelligence company that claims to be the world's first commercial producer of neuromorphic processors that can mimic the way the human brain processes sensory inputs.

Brainchip's Akida neuromorphic processor has already found applications in the fields of smart car development and autonomous driving technology.

As an AI company, Brainchip's share price could receive a boost from the huge buzz surrounding the potential of generative AI technologies such as Chat GPT.

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