By Jimmy Burns, a fund manager at First State Despite difficult economic conditions, the Europea...
By Jimmy Burns, a fund manager at First State
Despite difficult economic conditions, the European small-cap universe continues to be a stockpicker's paradise.
In Europe, the majority of broker research remains focused on large-cap stocks, leaving a pool of interesting investment opportunities from a broad selection of industries in the small-cap arena.
The potential exists to identify and invest early in some of the leading blue chips of the future while taking advantage of relatively cheap valuations.
Compared to their larger counterparts, smaller companies offer more attractive valuations and significantly faster growth prospects.
Small-cap companies are currently trading at a 30%-35% discount to larger companies but, in the year to 30 June 2002, outperformed due to cheaper valuations and the tendency for such stocks to be exposed to the more cyclical areas of the economy.
The small-cap SSB EMI Europe ex-UK index outperformed the MSCI ex-UK by 2.5%.
Due to their increased liquidity, we expect large-cap companies to lead the next major bull market. The recovery for smaller companies will follow, especially as the economy recovers.
In current conditions, many small-cap managers have sought refuge in defensive, or more cheaply-rated, sectors, such as construction or engineering. As everyone rushes into the same stocks, it will pay to remain focused on EPS growth.
Recent developments in European markets have further enhanced the outlook for the small-cap sector. The advent of the single economy has accelerated consolidation, widening the scope for cross-border takeovers.
Better protection for minority shareholders has encouraged large-cap managers into the sector.
As they move in, nimble small-cap managers can cash in the profits and look for new targets.
Current themes set to thrive as market barriers are broken down include the privatisation of European healthcare; the outsourcing of services such as security, temporary employment and HR functions; and private wealth management.
In-depth research, including due diligence and close attention to the financial strength of a company, is key to good stock selection.
Some smaller companies are tempted to grow too quickly, without the proper financial or management control.
We prefer to invest in stocks that produce positive, free cashflow.
Meeting the management team is vital to assess its quality, length of service and attitude towards minority shareholders.
As management tends not to change very often, the past track record can provide a good guide to the future.
It is sensible to have exposure to the smaller company sector as a means of diversifying portfolios and to benefit from investing in tomorrow's winners at bargain prices.
The long-term picture continues to look good for European equity markets generally, with pension reform providing support to equity markets.
Despite repercussions from the internet bubble, underlined by the de-listing of some Neuer Markt companies in Germany, the sector is generally in good health.
Recent falls in share prices have unearthed interesting opportunities and investors with a long-term investment horizon can find attractive opportunities.
Euro smaller cos offer myriad opportunities.
Market encouraging consolidation.
Smaller companies offer faster growth.
Economic recovery is stalling.
Major market rally will be led by large caps.
Market not rewarding earnings outlook.
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