According to the folks at Liberum Capital, small and mid-sized companies (SMIDs) are the most likely source of value in a volatile year for stock markets. The brokerage has just put out its annual SMIDs report, which includes recommendations for mid-tier stocks, including IC buy tips Volution (FAN) and Safestore (SAFE). We've taken five charts from that report which suggest reasons to be bullish about small(er) stocks, and one which spots a looming potential headwind.
Earnings looking good
Earnings growth forecasts for FTSE Smal-Cap and Aim 100 companies currently outstrip larger peers. While Liberum analyst Sebastian Jory believes these estimates are "unbelievably bullish" across the board (more than 25 per cent growth in the FTSE Small-Cap index certainly looks optimistic), he maintains the view that SMIDs should do well in the next three years.
Valuations lower than larger peers
Despite the growth expectations, constituents of the FTSE Small-Cap index come with cheaper average valuations relative to larger caps, as shown in the steady drop off in multiples for stocks sitting directly outside the FTSE 250.
If you strip out oil...
Many of the EPS growth forecasts include a reversion in commodity prices, which could prove to be wishful thinking. But strip out cheaply weighted resource stocks - which Liberum cautions makes up a good chunk of the aggregate forecast growth - and there still appears to be value in the sector, with average price-to-earnings multiples only slightly higher.
World-beating performance
Of course, cheap doesn't always deliver, but small-to-medium cap UK companies have an excellent track record. Over the past five years, Liberum believes the group has collectively been the best performing asset class anywhere in the world, according to the Investment Association trade body definitions.
Toppish valuations, but in range
Despite this outperformance, and unlike the FTSE 250 and large-cap European stocks, FTSE Small-Cap valuations are within the range of historic PE ratios. Nonetheless, they remain at the top of that range.
But value may not pay
This share premium could suggest that stocks may have further to fall if we are entering the end of a very long bull cycle. A glance at the last late cycle in 2005-08 shows a value-based investment approach to SMID stocks failed to pay off.
