Invesco Perpetual - Investing in UK Smaller Companies
The UK smaller companies sector has over many years generated good returns for investors.
Over the last 60 years to the end of 2015, the sector, as measured by the Numis Smaller Companies Index (ex-investment trusts), has on average returned over 15.4% per year on a total return basis.
We believe the market has many appealing characteristics for us as ‘stock pickers’. Small companies receive much less attention from analysts than their larger brethren, enabling us to profit from what we believe to be genuinely undervalued ‘hidden gems’. The managements of smaller companies also tend to own a much higher proportion of the shares in their own businesses, aligning their interests better with shareholders, and resulting in decisions being taken for the long term benefit of the business. Smaller companies can also gain exposure to smaller but higher growth niches within the economy, such as the production and distribution of research-grade antibodies via the Internet, which would be too small, and therefore not worthwhile, for a ‘mega-cap’ stock.
We look to invest in high quality businesses, on attractive valuations that have the scope to become considerably larger over the medium term. We seek companies with great products or services that enable them to take market share off their competitors, or companies that are exposed to higher growth niches. A business also needs to be able to make strong sustainable profit margins, with high ‘barriers to entry’ to prevent them being competed away, by having patents or strong brands, for example. We also expect the businesses we invest in to have strong balance sheets and to generate strong cash flows.
With increasing uncertainties in the global economy, in particular Chinese economic growth, and with an expectation that global growth is likely to be below trend whilst economies continue to reduce debt levels, we have invested in a number of businesses that we believe can grow through self-help rather than being reliant on the economy. This would include companies where there are new management teams restructuring their businesses such as Severfield (structural steel) and Majestic Wine (wine retail) or businesses that can drive synergies through sizeable acquisitions including RPC (plastic container manufacturer) and Savills (global property consultants).
We are always attracted to businesses that can drive growth through rolling out a successful concept, for example JD Sports which are expanding internationally as well as within the UK, or a business like CVS, the veterinary business, which is successfully consolidating a fragmented market.
We also hold a number of ‘structural growth’ businesses including 4imprint (promotional products) and boohoo (value fast fashion) both of whom are exploiting the Internet to potentially drive growth well ahead of traditional competitors.
Whilst we may continue to see some volatility within equity markets, we believe that the UK economy remains relatively robust, so it is no surprise that we retain a strong exposure to domestically orientated businesses.
Our investment approach is to focus on what we view as quality growth businesses. One of the beauties of investing in smaller companies is that you can find businesses that can continue to grow irrespective of what is happening in China or how volatile commodity prices are. The UK smaller companies sector appears reasonably valued to us. This view is corroborated by the increase in small company takeover activity we have seen over the last six months, suggesting that corporate buyers are also finding attractive value in the market.
All information as at 31 December 2015.