Buy more small caps, says Panmure Liberum. But which ones?
Now is the time to get back into British small caps, according to the boffins at Panmure Liberum.
Headline valuations, on a P/E ratio basis, don’t seem much different in the small caps compared to their big-cap counterparts. But Panmure says that when you adjust for differences in sector composition, you get an average discount of as much as 20 per cent for the small caps, meaning bargains abound.
The small caps have been pretty unloved the past five years. Big institutional investors like pension funds have largely withdrawn from this sector of the market, while retail investors, if they haven’t just thrown everything at the Mag 7, have opted for UK trackers that exclude those outside the FTSE 350. The number of London-listed small-cap businesses has declined massively over the past five years, as firms either delist or get snapped up by private equity on the cheap, and the shares have significantly underperformed London large caps.
But Panmure analysts say the tide is finally turning for the small caps. Smaller companies have ramped up share buybacks of late, improving liquidity and boosting valuations, while falling gilt yields typically spark their outperformance over the shares of bigger businesses. They also stand to be the biggest beneficiaries of a government push to get long-term investors like pension funds back into UK equities.
“We think there is a series of fundamental changes underway in the UK economy and UK financial markets that may boost UK small- and mid-cap performance,” analysts said.
“We estimate a rerating potential of up to 20 per cent based on a slight improvement in market liquidity and the acceleration in GDP growth, with a commensurate reduction in gilt yields.”
Shopping around
That all sounds pretty compelling. The trouble is, small caps are much harder to pick. There is scant equity research on many of the small-cap businesses, and the lack of long-term institutional ownership means the stocks moves can get very choppy and unpredictable.
City PM’s own team compiled a list of ten small and large-cap stocks at the start of the year. To date, just two of our five small caps are trading in positive territory (and barely), compared to four of the five large caps. Across the large caps, the portfolio is up 6.7 per cent, compared with a fall of 12.9 per cent across the small caps.
And that’s not just because we’re terrible stock pickers. Since the start of the year, the AIM 100 index is already well behind the FTSE 100.
It’s a bit like buying a car off of Facebook Marketplace rather than an approved dealer. You might find an absolute steal that lasts for years. But you also could find bricks for wheels.