Three British small-cap stocks with big potential

Professional investor Jonathan Brown of the Invesco Perpetual UK Smaller Companies Investment Trust picks three UK small-cap stocks that should provide meaningful returns.

Despite the economy suffering its biggest setback in 300 years, we think the building blocks are in place for a strong recovery in the second half of 2021. We believe there is considerable pent-up demand for both leisure and retail spending, and thanks to the high savings rate during lockdown consumption could be a driver of strong GDP growth from the summer onwards.

In addition, the Brexit trade agreement gives businesses certainty around trading arrangements with the EU, allowing companies to invest with confidence. Assuming the pandemic doesn’t take an unexpected turn for the worse, the pace of economic recovery could be higher than many people expect.

While the events of the last year have taken a heavy toll on individuals, companies and the economy, we face the future with optimism. We believe our approach of investing in good-quality businesses at sensible valuations remains the correct strategy for achieving long-term returns.

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For stockpickers such as us, the small-cap end of the market is an exciting place to be. By way of illustration, we believe that the three stocks below are particularly well placed to be able to contribute meaningfully to overall returns for the Invesco UK Smaller Companies Equity Fund.

Essentra: profits in plugs and packaging

Having lost its way under previous management, Essentra (LSE: ESNT), a manufacturer and supplier of caps, plugs, plastic, fibre, foam and packaging products, has been undergoing a transformation. The upshot is that the company is now concentrating on its higher-margin areas of component manufacture and distribution, healthcare packaging and filter products. All these areas offer significant growth potential, both organically and through acquisitions. The company’s transformation has gone largely unnoticed by the stockmarket, leaving the shares trading on a lower valuation than many other similar businesses.

RWS Holdings: a top translation business

RWS Holdings (Aim: RWS) recently merged with SDL to create the world’s largest translation business. RWS has a strong reputation for quality and leads the market in the highly specialised areas of patent and healthcare translation. The merger with SDL offers the potential for both significant cost savings and an acceleration in growth as the group harnesses SDL’s market-leading translation technology to expand into new fields.

Hollywood Bowl: a star performer

Hollywood Bowl Group (LSE: BOWL), one of the UK’s leading tenpin bowling businesses, has come under pressure in the pandemic, like all leisure companies. While its premises are closed for now, we believe that there is a lot of potential for it to recover strongly once lockdown is over.

The sector has suffered from a lack of investment for years and we have been impressed by how Hollywood Bowl has taken the opportunity to upgrade its offering to include better-quality food and a more premium experience overall – at a price that remains relatively affordable.

The business has significant growth potential, both from opening additional bowling outlets and from its new indoor-golf format Puttstars. The shares are still trading well below their pre-pandemic level.

Jonathan Brown managers the Invesco Perpetual UK Smaller Companies Investment Trust