As investors we do need to seek out opportunities when the exuberance or caution of markets is exaggerated. It is tough to make the right call consistently but at times there are opportunities that in hindsight were ‘obvious’ but at the time seem to present too much risk to commit the capital – it is sometimes hard to have the courage of our convictions.
I remember being encouraged to buy shares in Barclays Bank during the banking crisis, turns out that I should have as they could have been bought at under 60p and currently trade today at £2.98 (20th Feb 2025). At the time it felt that any bank could go bust so caution prevailed and sadly, an opportunity was missed.
VOLATILITY
What we are aiming to achieve with our clients’ money of is ‘Risk adjusted returns’. What we mean by that is not too much risk (the ups and downs) but just the right amount of up – over time.
While smaller companies can be more volatile, the flurry of M&A activity seems to demonstrate that private equity houses and trade buyers share this view about the exceptional value on offer.
There are signs that sentiment is improving and this should continue especially if the path of interest rate cuts becomes clearer. Any moves by politicians to encourage investment by pension funds into smaller growth companies, as part of plans to revitalise the UK stock market is to be encouraged as more buyers/investors will mean higher stock prices.
There is no doubt that high-quality smaller companies, many of them in industries benefitting from powerful structural growth trends, can continue to outperform their larger counterparts over the long-term.
HOW CHEAP ARE SMALLER COMPANY SHARES?
There are five primary reasons why smaller companies now offer a compelling long-term opportunity. These are; highly attractive valuations, a flurry of merger and acquisitions (M&A) activity, improving sentiment, policy measures designed to increase investment in UK companies and exposure to structural growth trends.
The chart below shows how share prices compare to historical valuations.
THREE-YEAR ROLLING RETURN DNSCXI VS FTSE 100
TIMING OF ANY INVESTMENT
The ideal time to buy shares is when the market is pessimistic and so the shares are not wanted, possibly for good reason and the ideal time to sell is the opposite. This is the perpetual conundrum, buy at the bottom and sell at the top!
Let’s assume that this is impossible and if we can accept that fact then the strategy I personally prefer is to buy early and sell early. The issue on the buy side is patience, after all, the market has to agree with the value of a stock or stocks for the share price to increase and frankly, no-one knows exactly when that will happen. Being out early is also so much better than trying to sell a stock that no-one wants to buy.
However, there are indicators that give us some encouragement that good times might be ahead and that is all about making sure that the analysis is well thought through and the fundamentals are compelling.
WHERE ARE THE RISKS?
The world is clearly in a time of significant upheaval. The US administration has an agenda that is so very different from the last administration and this could have the effect of sending the world into recession.
The risks of being an investor are clearly heightened especially as we struggle to predict what will actually happen as a result of the trade spat initiated by the US and the imposition of tariffs. This debacle could impact the direction of interest rates as we may end up with more inflation than central banks have been predicting. This could further damage the price of small company shares so any investment isn’t without risk.
INVESTING OVER TIME
This really illustrates the importance of investing over time. In the short term we may see a much more volatile year for markets, large companies may struggle to hit expectations, global trade might slow due to trade tensions and conflict will almost certainly rumble on.
I do believe that this year will be a positive year for investors, but it would be unwise to be blind to the risks, but it is equally unwise to completely miss an opportunity due to decisions that are governed by short-term considerations only.
Please contact NBL if you need to speak to us.
