Put your trust in small companies

Despite a dire 2018, the long-term trends in the small companies sector are encouraging.

Smaller companies can turn their fortunes around, generating spectacular returns

Last year was one to forget for investors in smaller companies, says Professor Paul Marsh of the London Business School. The Numis Smaller Companies Index (NSCI), the bottom 10% of the UK market, returned -11%, 2.3% behind the FTSE 100. However, if investment companies are excluded, the gap increases to 6.6%, and if companies listed on Aim are included, to 7.1%.

Advertisement - Article continues below

The NSCI is made up of all 707 stocks (of which 348 are investment companies) with a market value below £1.33bn, and has a combined value of £231bn. Including Aim, it comprises 1,617 companies worth a total of £307bn. This compares with the £1,814bn value of the FTSE 100 index.

Small-cap managers have many more companies to research than their large-cap counterparts, each with far less research coverage, less accessible management and more risk. It wouldn't be worth bothering unless smaller companies outperformed larger companies over the long term.

Small but mighty

So is this a good time to invest in smaller companies both for a shorter-term catch-up and for the longer term? Probably, but there are some caveats. While smaller companies look cheap in absolute terms on a price/earnings multiple of 10.9, below the long-term average of 12.7, this is only a little below the 11.2 multiple for the All-Share Index. Outperformance by smaller companies in 2019 will require better earnings growth (this is despite evidence from the longer term that value outperforms growth).

Advertisement - Article continues below

Other factors which help outperformance are a focus on lower-risk stocks, a sceptical approach to new issues and, above all, a strategy of running winners and selling losers. Companies can turn their fortunes around, generating spectacular returns for investors, but it is much harder in the small-cap arena than for larger companies. Aim's performance last year was disappointing, but Marsh is encouraged by some longer-term trends. The proportion of foreign companies has fallen, while the avalanche of new issues has abated. By number, 45% of Aim companies are profitable, and 75% by value, while 32% and 63% respectively pay dividends. In 2000, just 25% by value were profitable. Unsurprisingly, smaller-companies fund managers have been increasing their allocation in recent years.

Why trusts are better

Small-cap trusts such as BlackRock (LSE: BRSC), Throgmorton (LSE: THRG), Henderson (LSE: HSL), Invesco Perpetual (LSE: IPU), JP Morgan (LSE: JMI) and Standard Life (LSE: SLS), each ahead of the average over almost all time periods, are well worth backing.





Investment trusts

If you think now is a good time to buy, look at these investment trusts

With the latest market slides, an awful lot of assets are beginning to look very cheap indeed. If you are thinking of buying, Merryn Somerset Webb has…
10 Mar 2020

How to build a properly diversified investment trust portfolio

Max King explains how to build a well diversified portfolio using one of our favourite tools – investment trusts.
25 Feb 2020

Why investment trusts are the best vehicle for your money

Max King explains the advantages of investment trusts – sometimes called closed-ended funds – over their open-ended counterparts (or Oeics).
11 Feb 2020
Share tips

Share tips of the week

MoneyWeek’s comprehensive guide to the best of this week’s share tips from the rest of the UK's financial pages.
17 Jan 2020

Most Popular

UK Economy

What bounce back loans can tell us about how we’ll pay for all this

The government will guarantee emergency "bounce back loans" for small businesses hit by Covid-19. Inevitably, many businesses will default. And there'…
1 Jun 2020

This looks like the biggest opportunity in today’s markets

With low interest rates and constant money-printing, most assets have become expensive. But one major asset class hasn’t. John Stepek explains why com…
2 Jun 2020
Global Economy

The MoneyWeek Podcast: James Ferguson on the virus, the lockdown, and what comes next

Merryn talks to MoneyWeek regular James Ferguson of Macrostrategy Partnership about what's happened so far with the virus; whether the lockdown was th…
28 May 2020