Why Investors Are Rotating Into ASX Small Caps- 5 Top Picks for 2026

ASX Small Caps Are Back on the Radar for 2026

An interesting development occurred on the ASX in 2025. While most investors focused on big, well-known stocks, ASX small-cap shares quietly performed much better. The Small Ordinaries Index rose by almost 25 per cent for the year, which is about 2.5 times more than the wider market, according to S&P Global. Even so, small-cap shares are still priced very cheaply compared to large caps, sitting near 25-year valuation lows based on data from VanEck. This suggests the shift into small caps may still be in its early stages.

At the same time, Commonwealth Bank (ASX: CBA) is trading at around 27 times earnings, making it the most expensive major bank in the developed world. This is despite profit growth being only in the low single digits. More experienced investors are starting to see this valuation gap and are slowly moving away from large caps towards smaller companies.

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Why the Rotation Is Happening, And Why It Has Further to Run

The case for ASX small caps comes down to one simple idea: better growth at a lower price. Earnings growth for the ASX 200 is expected to be close to zero in FY26, while small caps are tracking around 10 per cent, according to Lennox Capital Partners.

A late-2025 Reuters analysis confirmed investors were already rotating out of expensive blue chips into smaller companies. The recent RBA rate hike to 3.85 per cent might sound like a headwind, but the Small Ordinaries is heavily weighted towards resources, with gold alone making up around 17 per cent of the index, offering natural protection that rate-sensitive sectors lack.

The themes driving this shift are real: defence spending under AUKUS, critical minerals backed by government financing, and semiconductor technology hitting commercial milestones. These are structural tailwinds, and smaller companies are best placed to ride them.

5 ASX Small Caps To Watch

Duratec (ASX: DUR) is quietly building a dominant position in defence infrastructure. The company has worked on the HMAS Stirling naval base since 2015 and is now involved in early procurement for AUKUS submarine upgrades, with roughly AUD 8 billion in spending expected at the site. Major contract awards are due later this year, and we think the market has not priced in the scale of what is coming.

Northern Minerals (ASX: NTU) is one of the few Western companies with a heavy rare earth project, producing materials that China controls more tightly than almost any other commodity. A US EXIM Letter of Intent for financing gives this one genuine government backing, not just a good story.

Weebit Nano (ASX: WBT) has turned a corner. Customer receipts jumped sharply in the latest quarter, the company hit positive operating cash flow, and a successful tape-out at onsemi’s facility signals that commercial adoption of its memory technology could arrive sooner than expected.

Bellevue Gold (ASX: BGL) had a bumpy start to production, but the turnaround is real. The company finished FY25 with record quarterly output, selling gold above AUD 5,000 an ounce. At its current market cap, it is one of the cheapest producing gold mines on the ASX relative to its high-grade resource.

Novonix (ASX: NVX) makes synthetic graphite using a process that consumes 30 per cent less energy than traditional methods. New US tariffs on Chinese graphite are improving its competitive position, and institutional investors like BNY Mellon have been increasing their stake. This is a battery materials play with genuine technology differentiation.

The Investor’s Takeaway

Small caps are riskier than blue chips, and plenty of cheap stocks are cheap for good reason. The key is being selective. Look for companies that are profitable or close to it, have strong balance sheets, and show insider buying. Dollar-cost averaging is smarter than going all-in at this stage. The setup for quality small caps is the best in years, but quality is the keyword. Be selective, not greedy.