Three global small-cap stocks with big potential

A professional investor tells us where he’d put his money. This week: Erik Esselink, European equities fund manager, Invesco, highlights three favourites

Global small-cap stocks often fail to gain the attention they perhaps deserve. Their appeal is frequently either underappreciated or overlooked, especially when the dominant narrative and newsflow routinely revolves around the attractions of Big Tech behemoths with trillion-dollar market valuations. Yet small-cap performance has been strong – and not just since the Covid-19 crisis.

Smaller companies have considerably outperformed larger companies since the turn of the century. This has been driven primarily by faster revenue and earnings growth, and we expect this to continue. While it is true that small-cap stocks can be more volatile than large caps, historically investors are rewarded with higher returns.

An encouraging worldwide backdrop

We see several good years of global economic growth ahead, and we believe this will make for an attractive environment for small-cap investing. We also expect mergers and acquisitions to be another important driver for small caps. Sometimes we buy from private equity and larger companies; more often we sell our businesses to them, normally at a significant premium.

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Our focus is on identifying companies with durable, sustainable business models, where we have a differentiated view and see scope for a bargain to produce strong returns. While we continue to see attractively valued companies in most parts of the world, we would caution that valuations are somewhat stretched in those stocks and sectors popular with the consensus over the last 12 months. We think the stocks below, held within the Invesco Global Smaller Companies Fund (UK), are attractively valued.

A chemicals group with the right formula

Denka (Tokyo: 4061) is a chemicals company with significant global shares in highly profitable niche areas. Spherical alumina is a good example of a high-margin product with strong growth potential as it is used for electrical insulation and heat dissipation in electric-vehicle batteries. Products for the semiconductor and healthcare industries add to the company’s long term growth outlook.

The outlook at Samsonite (Hong Kong: 1910), the well-known global luggage brand, is also auspicious. The problem it has faced recently is that when no-one travels, no-one buys much luggage. However, the brand is super-strong and its scale leads to durable advantages in procurement, distribution, and research and development. As a result, it remains the global leader and sales should bounce back with the recovery from Covid-19. It has also used the sudden-stop experience of the pandemic to reduce costs, so we think it will emerge more profitable than ever when we get back to normal.

A bright future in LED lighting

Signify (Amsterdam: LIGHT) is a global leader in LED lighting solutions. While LED lighting is a highly competitive area, Signify has remained a leader in more complex “connected LED” solutions, whereby lighting is combined with IT systems. These offer companies even greater energy savings and better margins. There is ample scope for growth in this sector as we aim for a zero-carbon future and benefit from infrastructure stimulus packages around the world. Furthermore, Signify’s recent acquisition of Cooper in the US allows them to improve margins significantly in its corporate division.

Erik Esselink

Erik Esselink is European equities fund manager at Invesco