In the third of our four-part series on small caps (you can read part two on UK small cap funds and trusts elsewhere in this issue), we get our data-crunching caps on and take a look at key metrics around value, income and growth in the smaller companies universe.
To narrow things down we limited our search to London-listed companies with market valuations between £50 million and £500 million. We present the results here – but remember, numbers can only tell you so much and these lists are intended as starting points for further analysis and research.
VALUE
One thing UK small caps certainly are not is expensive (as we pointed out in the first of these articles), so we kick things off by looking at some of the companies with the lowest PE (price to earnings) ratios.
We have avoided anything with a PE ratio below four on the basis it implied questionable data and/or that the forecasts are just not believed by the market.
Over-50s lifestyle outfit Saga (SAGA) and pubs group Marston’s (MARS) are both businesses with significant levels of borrowings but, in fairness, both have plans to deleverage.
There is a smattering of resource names in the list, reflecting the poor sentiment towards small-cap oil and mining names. This makes sense when you consider they mine and drill for commodities over whose pricing they have zero control. It doesn’t help that there have been few recent success stories in the small-cap energy or mining space to generate investor excitement.
It is important to note that a low PE is always just a starting point, it doesn’t tell you for example how much debt a company has on its balance sheet nor does it show you if earnings are growing.
One way of incorporating earnings growth is to look at the price to earnings growth or PEG ratio, which divides the PE by the expected EPS growth rate.
Interestingly, there are a few fallen giants on this list including former FTSE 250 constituent, oil services firm Wood Group (WG.), and Martin Sorrell’s digital advertising vehicle S4 Capital (SFOR).
Some of these names have made the list because earnings are rebounding from a big sell-off, which explains the combination of high earnings growth and a low PE.
INCOME
Most people probably don’t think of dividends first when they look at small caps, but many smaller firms do provide a steady stream of income. To arrive at our list we looked for the highest-yielding stocks in our selected subset of the market with dividend cover of at least 1.5 times - in other words, those where the dividend per share is covered at least one-and-a-half times by earnings.
Top of the list is Peruvian oil and gas producer PetroTal (PTAL:AIM). While a double-digit yield is typically a sign the market thinks the dividend is at risk of being cut, chief executive Manolo Zúñiga recently told Shares: ‘We have promised investors we will continue giving back money to them through dividends.’
Zúñiga points out his family also enjoy dividends from the company, so their interests are aligned with other shareholders in that regard.
Other names to catch our eye include newspaper and magazine distributor Smiths News (SNWS), newspaper publisher Reach (RCH) and structural steel specialist Severfield (SFR).
Leaving the PetroTal example aside, high yields can be a sign that a payout is vulnerable so it does require some careful research to determine if dividends are sustainable.
Dividend cover is a useful initial check, but dividends are paid out of cash, not earnings, so you will often have to dig a bit deeper to gain greater comfort.
In any case, this list is meant as a reminder that small caps shouldn’t be ignored in the quest for income.
GROWTH
Finally, we arrive at one of the key reasons investors look to buy small caps – growth. To avoid names where growth is simply a flash in the pan we’ve looked at the companies with the highest forecast annual earnings growth which have delivered positive annualised earnings growth over the last decade.
Recruiters Robert Walters (RWA) and SThree (STHR) make this list (with earnings seen as recovering from a difficult period), as do engineering and electronics plays like Avingtrans (AVG:AIM), Judges Scientific (JDG:AIM) and TT Electronics (TTG). The extreme nature of the uplift in Robert Walters’ earnings reflects a previous drop to negligible levels.
Also making the list is chemicals firm Zotefoams (ZTF), which manufactures specialist foams used in Nike’s (NKE:NYSE) high-performance footwear.
These articles are provided by Shares magazine which is published by AJ Bell Media, a part of AJ Bell. Shares is not written by AJ Bell.
Shares is provided for your general information and use and is not a personal recommendation to invest. It is not intended to be relied upon by you in making or not making any investment decisions. The investments referred to in these articles will not be suitable for all investors. If in doubt please seek appropriate independent financial advice.
Investors acting on the information in these articles do so at their own risk and AJ Bell Media and its staff do not accept liability for losses suffered by investors as a result of their investment decisions.
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