When it comes to smaller companies, don’t just look for tomorrow’s leaders—look for today’s
Over the past 60 years, UK mid- and small-cap stocks have outperformed their larger counterparts in roughly two out of three years . A number of factors have been suggested to explain this long-term outperformance
Over the past 60 years, UK mid- and small-cap stocks have outperformed their larger counterparts in roughly two out of three years1. A number of factors have been suggested to explain this long-term outperformance, mostly focusing on the characteristics of small-cap companies that allow them to react quicker, grow faster and/or disrupt existing markets with new and exciting innovations. While all these things are true, providing convincing reasons to invest in some small-cap companies, such explanations do risk painting a picture that all smaller companies are early stage businesses, with the associated ups and downs that brings.
Discovering today’s market leaders
While we are constantly on the lookout for the next big thing, it is important not to lose sight of those companies that may already be the big thing, only in a smaller market. Some of the best mid and small cap opportunities we see come from companies that are already established leaders in their niche areas. While they may not have a unicorn’s2 appetite for global domination, the small- and mid-cap universe is rich with companies with strong market positions and sensible capital allocation policies that are generating good returns and have a track record of operational delivery and cash generation. Often because these companies operate in less exciting or newsworthy industries, they can float under the radar and be found at a valuation that belies the quality of the business.
Two industry leaders you might never have heard of
Coats is a FTSE 250 company and the world’s leading industrial threads business, supplying the threads for everything from your running shoes to the telecommunication cables bringing connectivity to your home. The company can trace its roots back to the 18th century but despite its advancing years was an early adopter of technology solutions, helping to digitise the supply chain and drive home its advantage over the rest of the market. Having cleared outstanding pension issues, Coats is now free to use its capital to invest in design, safety and sustainability, helping to consolidate its market position and exploit market trends towards environmental sustainability and high performance threads.
Polypipe is the largest supplier of plastic pipe systems for commercial and residential projects in the UK. As industries go, plumbing and sewerage must be one of the least attractive industries to talk about but as a business Polypipe has managed to grow adjusted earnings at over 20% pa over the past five years3, driven by a substitution of legacy materials for lighter weight plastic.The company has recently acquired a new drainage technology called Permavoid, which is being used to tackle water management issues in urban areas impacted by climate change. This technology has also been included in the Anfield football pitch to help regulate moisture levels – and with Liverpool unbeaten at home this season in both the Premier League and Champions League, it might not be too long before Polypipe’s brochure finds its way around more football clubs!
Looking under the radar
Successful small-cap investing can be about looking to the future and identifying the winners before others have – let’s call that approach “discovering tomorrow’s leaders today”. But there is also an opportunity to identify great investment opportunities in companies that already have well established markets, leadership positions and track records. Whether it’s because of their smaller size or because they operate in less newsworthy industries, these companies can float under the radar, offering good value for the eagle-eyed investor.
Timothy Lewis is an analyst in the J.P. Morgan Asset Management International Equity Group – Behavioural Finance Team, focusing on small and mid-cap.
1 Numis Smaller Companies Index 2018 Annual Review – Numis/ Elroy Dimson, Scott Evans and Paul Marsh – London Business School.
2 A privately held early stage company valued at over $1billion
3 Company reports. Adjusted diluted earnings per share Dec 2013 to Dec 2018. Past performance and yield are not a reliable indicator of current and future results.