What I learned from 15 years of investing in small companies
Max King spent 15 years managing funds in the small-companies sector. Here he reveals the secrets of long-term investment success
In early March, Spirax-Sarco Engineering’s results for 2020 caused the share price to rise by 380p. What made this catch my eye was not the size of the jump – less than 3.5% from £110 – but that 380p was far more than I remember paying for shares in the group, which makes steam-management systems and pumps, for the small-cap trust I started running in the late 1980s. Since then, the shares have multiplied 50-fold, excluding dividends.
This made me dig out old reports to see what else had survived and prospered. Maybe there would be some lessons to be learned from my 15 years of managing UK small-cap funds, a job I embarked upon in the late 1980s. My style had been based on “reassuringly expensive” long-term growth companies with a sprinkling of high-risk turnaround stories. Some investments, such as Spirax-Sarco, were held throughout and I would still be holding them today if the trust and I had stayed put. Others always had a sell-by date on them.
Many of the holdings were subsequently taken over, some after exceptional performances, some having fizzled out. Some I gave up on (usually wisely) and some were duds. But what stands out are the long-term winners that have survived. These by themselves would have ensured a reasonable long-term performance if held until today. It supports Baillie Gifford’s research showing that just a few companies account for all the long-term performance of the US stockmarket.
With the exception of Aveva, up 80-fold in 25 years, these companies were not in the technology and biotech sectors. Some of the stocks in those industries performed spectacularly in the short term, many were taken over, but no others have survived. I was always wary of small mining and energy companies, believing that their global ambitions were unrealistic. Those I invested in did fine but were all taken over. Financials were another sector to be wary of: few firms can sustain a competitive advantage for long. Wealth-manager Rathbones has done well, though its stock has dropped by 40% from its 2017 high.
A simple but brilliant idea
The share price of Shaftesbury is down by more than a third from its 2018 peak but has still multiplied tenfold since the Levy family started to invest in central London “villages.” Their thesis, simple but brilliant, was never to invest in anything more than a 15-minute walk from their offices so that they could keep a close eye on buildings, tenants and opportunities. By focusing investment on tightly-knit areas they could turn them into destinations, press for local improvements in streets and footfall, and lift the value of the villages. Housebuilder Berkeley, which initially sold upmarket built-to-order houses before moving into urban regeneration, had a comparable policy of adding value through landscaping and lifting the desirability of locations; its shares have multiplied 100-fold since 1990.
Several of the long term winners are, like Spirax-Sarco, in the industrials sector, including Rotork, Renishaw and Weir. Investing in these at a time when British industry was in relentless decline was counter-intuitive, but innovation and the application of the latest technology were key to their success.
I bought Rotork in 1990 after a daytrip hosted by Severn Trent Water. This included a visit to an unmanned and fully automated water-treatment site reliant on Rotork’s valve actuators to control the process. It was also clear that rebuilding Kuwait’s oil infrastructure would be a bonanza for the likes of Rotork. The shares have since multiplied more than 100-fold. Weir’s shares have risen 30-fold since the late 1980s, though they are 30% below their 2014 peak. Oxford Instruments was a perennial disappointment but its shares have still risen tenfold in 12 years.
Renishaw, up 50-fold, has also been volatile largely because of its vertically-integrated business model. The business was based on the invention of a probe for ultra-accurate measurement and developed into various applications of the technology. Against conventional wisdom, Renishaw didn’t believe in subcontracting any manufacturing; they maintained that only by going through the whole process themselves, including designing and producing the machine tools, could they learn how to do it better and gain new ideas.
People-businesses can rarely sustain a competitive advantage for long. Rathbones, founded in 1742, was clearly worth the benefit of the doubt and so was Savills, founded in 1855. Estate-agency is a cyclical market but international expansion has made it less so and the shares have multiplied 20-fold.
Spirits go upmarket
Simple, obvious good ideas have always been worth backing even if management has had to learn on the job. Dechra Pharmaceuticals, specialising in veterinary products but with ambitions to develop its pet-pharmaceutical arm, was floated in late 2000 at 120p and quickly rose to nearly £2. The shares then fell by 75% in the next two years but now trade at nearly 30 times the flotation price. A more recent example is Fever-tree, bought by the private-equity arm of Lloyds Bank in 2013. The press was outraged that a bank bailed out by the government was spending £25m on a firm with profits of just £1m.
I asked a friend who worked in Lloyds’ private-equity business. He explained that the spirits market was fragmenting and going upmarket. People would not want to consume high-quality spirits with bog-standard mixers, providing an opportunity for a new brand. The business was floated in 2014 and is now valued at nearly £3bn.
Another happy hunting ground was “roll-out” companies. Find a retailer or restaurateur that has identified a good concept in a few locations and has the potential to roll the idea out nationally. Fashions don’t last for long, economies of scale don’t always apply and once chains reach maturity, they tend to decline. So it’s important to sell out in time. Next, launched by George Davies in 1981, is the exception that proves the rule.
The business model of Cityvision, a chain of video-rental stores, relied on recycling old stock into new stores, so it required an exit when expansion peaked. The first restaurant of the Pelican group, a brasserie in St Martin’s Lane, London, had been set up by a former colleague (previously a civil servant). Her family sold out to new management who rolled out the concept as Café Rouge and multiplied my money sevenfold. A month after I sold out, they accepted a bid from a major brewery, recognising, as I had, that it was time to exit.
French Connection was tipped to me by a friend in the fashion trade at a parents’ evening. Within a week, I had visited Stephen Marks at his office in Chelsea and bought the shares. He had recently adopted the FCUK brand, inspired by the logo that French Connection’s in-house football team had chosen for their strip. The shares soared but this was never going to be another Next. Superdry and Ted Baker have since burned out in similar fashion although Boohoo prospers – for now.
Don’t bet the farm on recovery stories
Solid and steady survivors such as Marshalls (landscaping products), Travis Perkins (builders’ merchants) and Greene King (pubs) have been good long-term investments but tripped up and became recovery stocks along the way.
Games Workshop has risen 20-fold in five years but had been a recovery stock three times previously. The lure of recovery is the prospect of multiplying your money in a share everyone else hates but it’s not an area to bet the farm on.
I was charmed into Bluebird Toys by its CEO, Torquil Norman (father-in-law of venture capitalist Kate Bingham) who had been a popular client in my short spell in corporate finance. The success of “Polly Pocket” caused the shares, previously on the rocks, to multiply. The version aimed at boys, “Mighty Max”, was named after me after a humorous exchange at the Earl’s Court toy fair. I cashed in soon after.
My most spectacular success was the most reckless. I bought two million shares in Cannon Street Investments at 2p, down more than 99% from their peak in late 1992 on the sole basis that Tom Long, whom I knew of as the former CEO of Souza Cruz (a subsidiary of British American Tobacco) had become chairman. The shares multiplied tenfold in a year or two as a messy, over-borrowed conglomerate was streamlined through disposals. I then sold.
Regrets: I’ve had a few
My biggest regrets are not the duds I bought but the great companies I missed. Channel Express floated in the mid-1980s as an air-freight business. Its boss, Philip Meeson, had been a Red Arrows pilot and then began importing 2CV cars from France and selling them from a lot on the King’s Road, London. The site was converted into a BMW dealership and later sold. Though Meeson was clearly a serial-entrepreneur, I didn’t see a long-term investment thesis. The company is now called Jet2 and the shares have multiplied more than 100-fold.
Another regret was Asos. In early 2004, we identified this online retailer, whose idea was to replicate cheaply and quickly clothes worn by celebrities, hence the name “As Seen on Screen”. We recommended the shares to our clients in the monthly newsletter at 25p... and suggested taking profits after they had doubled in six months. The shares then multiplied 100-fold in ten years but have had a yo-yo ride since. I hope some clients didn’t sell.
What are the lessons? The best long-term investments are not the get-rich-quickly companies but those offering long-term compound growth. Holding them requires nerve and patience as the shares are often volatile and can stagnate for long periods. It is tempting to give up and sell. If an investment is not suitable for the long-term, it’s best to be clear about that at the start as it makes selling easier.
Buying for recovery can also be hugely profitable but these are rarely “forever” investments. Finally, great investments are not found through diligent research and endless company presentations but through casual recommendations, chance encounters and inspiration, not perspiration. As John le Carré wrote: “A desk is a dangerous place from which to view the world.”