1/27/2024 0 Comments Ik smallandMispricing - on a par with dotcom aftermath? Such a dramatic underperformance has also, on average, been a precursor to a period of strong outperformance versus the FTSE 100 (see chart below). Looking back over the past three decades, however, for UK smids to have underperformed by almost 30% is statistically rare. ![]() Smids tend to reinvest more of their cashflows to grow - ‘free’ cashflows (for potentially returning to investors) are further out, so rising discount rates erode their present value by more. They’re expected to return more cash to investors (through dividends) over a shorter period of time, offering greater certainty, which is appealing at present (see: What is the outlook for UK dividends in a less certain world? ). This contrasts to a 6.2% gain in the FTSE 100, whose globally diversified banking, oil, mining and healthcare companies are seen to be more reliable cash generators. On some measures it may seem that the market has already priced in a lot of bad news for UK smids, which have fallen by 22.6% over the past 12 months (to 31 August 2022, on a total return basis). They could come into their own as they’re better able to mitigate the impact of shortages and higher costs.” Some of these companies, with very niche products, will be better able to pass on their own rising costs, further supporting their earnings. Jean Roche, UK mid cap fund manager, said: “There are UK businesses with sufficient ‘pricing power’ to withstand high inflation. ![]() For them, leading companies can capitalise, increasing their market share as ill-equipped competitors struggle. They are also aware of a market at times in panic mode and failing to discern between different companies with differing abilities to cope with the challenges. There are no definitive answers to such questions, nor other pressing ones about the potential depth and timing of the next recession, which is expected to sweep across many developed countries.Įxperienced investors, however, want to establish the degree to which tougher times ahead have already been priced in. Do these interventions mark a turning point? Has consumer inflation, which was higher than 10% for a period in the summer, already peaked, and will near-term interest rate rises be less aggressive than feared? A promised six-month energy package to help get firms through the winter will also relieve pressure on business-facing sectors. The Government has capped household energy costs for the next two years, easing fears around some UK consumer focused areas of the market. There are plenty of these well-run businesses with market-leading positions - it’s just that the ‘market’ is struggling to see them at present. That doesn’t mean, however, that they’re not world-leading companies capable of generating superior returns. Many UK smids – a grouping which encompasses more than 1,000 companies – may be less well-known. As long-term investors we are prepared to look through today’s gloom to identify the opportunities of the future, aware that history shows stock markets typically reach the bottom in advance of the worst news.” Sue Noffke, Head of UK Equities, said: “Many are fearful of what lies ahead for UK stocks. They’ll patiently ride out such periods, focused on opportunities others are predisposed to miss. ![]() However, market veterans are looking ahead and more interested in establishing how much of today’s bad news might already be priced in. Higher interest costs are squeezing consumers already struggling to cope with inflation – further crimping ‘discretionary’ spending on non-essential items such as clothing, holidays and meals out – at the same time as disproportionately weighing on valuations as discount rates rise.Īt a time when it might feel like the war against inflation – currently raging in many developed economies – has many more battles to be won, UK smids may not be a particularly comfortable place. In this regard, UK smids are doubly exposed to rising rates. Interest rates are a key component of the ‘discount rate’ at which an asset’s cashflows are discounted in order to work out their value in today’s money, or ‘present value’. The group is also home to many fast-growing companies in new and emerging industries, whose valuations have been badly hit by rising interest rates. This group includes many of the country’s quoted retailers, travel and leisure, construction and other domestically focused companies. Many of them are now pondering whether this is what’s currently happening with UK small and mid-cap (smid) stocks. Experienced investors know that markets often overreact to bad news.
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