They may have dipped below the radar of most fund managers, but UK smaller companies are full of pro...
They may have dipped below the radar of most fund managers, but UK smaller companies are full of promise at present prices say Gartmore's head of smaller companies Gervais Williams and senior investment manger Robert Giles.
With some 2,000 smaller companies to choose from it does take time to track down the more valuable investments, the two say, but as long as the liquidity is sufficient, the companies concerned are not under gearing pressure and there is anecdotal evidence of improvements, such as directors dealings, then there are good pickings to be had.
"There are lots of good ideas at the moment. We are very upbeat about the sector," Williams says.
The stock market overall fell further than expected because of earnings issues and technical reasons, such as life companies being forced to sell into a falling market, Williams says.
However, the expectation now is that life companies "are not going to sell more into the market", which could bring more stability to institutional demand, including for smaller companies.
The question to ask, he adds, is: Who is going to buy?
The answer seems to be directors, which are heavily into small caps at present; and companies themselves entering into share buybacks.
Takeover by other listed companies as well as private equity bids are starting to make themselves felt in the market too, exemplified by this week's interest in the retail sector – although IPOs are unlikely to stage a bigger comeback.
Shareholder dividends also remain strong in many cases, which will also raise interest in buying again.
Gervais Williams says he believes the wider markets are facing a situation similar to the one that developed between 1933-1937, when the US stock market gained about 100% as inflation was let loose as a lesser evil compared to deflation.
The US has signalled that it is moving towards reflating its economy, and, to a lesser extent, the UK, Europe and Asia are likely to follow, which should help drive share prices up in the longer-term.
There are also a lot of funds that are underweight in small cap stocks, which are likely to shift their asset around if there is continued improvement in indices.
When the market does move, it is likely to enable people to make good money in small caps, and even more so for active fund mangers who can pick and choose the most promising stocks, Williams adds.
He admits, however, that companies which got their earnings and profits forecasts wrong last year could be followed by others making similar exaggerations as to their future potential in the next 12 months.
Countering that risk are an increasing number of positive reports from companies followed by Williams' and Giles' team of analysts.
Downside risk remains in the form of, for example, further major terrorist incidents, but even this could result in sharply lower share prices that would remain buying opportunities once the fundaments of the companies concerned are taken into account.
What is more difficult, Giles adds, is the emergence of former FTSE 100 companies as small caps: examples include steel maker Corus, chemicals specialist ICI, which has touched on small cap territory on certain days, telecoms firm Marconi, and factory automations provider Invensys.
MyTravel and Regus are others currently trading at pennies, but which require talking to large cap equities analysts in order to establish what exactly are the potential upsides of buying into such companies.
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