Small companies offer the potential for growth that can exceed their larger peers over the long term, an assertion supported by the data. Small Companies offer investors early stage entry into names destined to become future global titans. Ausbil’s global small-cap team answer some key questions on how to access such unrecognised opportunities.
Q: Can you give us the elevator pitch for what you do?
TB: We find global companies that are early in their stages of development, are not actively covered yet by the market, and have latent, unrecognised growth prospects with the potential for major rerates and sustainable unrecognised earnings growth. Finding uncovered ‘gems’, the names that offer what we call ‘unrecognised growth’ is where an active global investment manager like Ausbil can help investors take advantage of smallcap idiosyncrasies, while helping to reduce the typical level of risk that come with early-stage small-cap investing. We like global small caps because over the long-term, smaller companies consistently show outperformance against their larger peers, as evidenced in Chart 1.
From Chart 1, since the inception of the MSCI indices in 2000, small companies have compounded well in advance of mid and large-cap peers. Over this twenty-plus years, small caps have risen by a factor of almost 6-times, mid caps buy almost 4-times, and large caps by the best part of 2.5-times. The outperformance of small companies has been shown consistently in the in the empirical long-term evidence provided by esteemed researchers such as Siegel (2015). Banz (1981) and Fama and French (1992), and in the market data.
Q: Can you explain the term, ‘unrecognised growth’?
SW: Unrecognised growth is where a company exhibits the signs and potential for future earnings growth that is conceptually ahead of peers or the market in general, but for which there is no consensus as the company is not yet covered by a bevvy of institutional analysts. The company is ‘unrecognised’ because, due to size, it is yet to become large enough to warrant broad institutional coverage. Chart 2 illustrates how analyst coverage changes as companies become bigger. Global small caps operate in a ‘sweet spot’ of opportunity that has yet to be noticed or acknowledged by the institutional equity research machine.
Ausbil’s global small-cap team seeks the opportunities in the 231 developed markets in which we invest before any reliable institutional consensus has been established. In the case of some companies, there might be a consensus based on the views of a handful of analysts, as illustrated in Chart 1, but there is typically a significant divergence in views on valuation, opportunity and risk. The essential idea is that we focus on companies where growth will surprise, in companies that are attractively valued, and which we believe demonstrate relatively less risk in proportion to the opportunity. Combined with a lack of analyst coverage, forward surprise potential at attractive valuations reveals companies with unrecognised growth, which ultimately drives share prices.
Q: Why do these companies go ‘unrecognised’ for a period of time?
TB: Fast growing smaller companies are proving their business models, their sales and earnings can be volatile, and their businesses can be undiversified in terms of steady-state earnings. Institutions, like insurance companies which are not specialist small-cap investors, typically look for larger-cap equities with steady historical earnings, and more mature business models. However, large super and pension funds often carry significant allocations to small cap equities for the superior long-term returns they can offer in equity portfolios. Small companies, when the fundamentals are sound, the management is strong, and the business model is relatively unassailable, can offer upside potential for investors who are comfortable with riding-out shorter term bursts of volatility. From the sell-side perspective, small companies are often supported by specialist financiers, angel investors, cornerstone investors, large insider holdings and small broking houses in their early years, before they graduate into the bigger leagues and into larger capital raisings with larger investment banks. This creates significantly more opportunity for astute smallcap investors to participate in funding rounds for businesses that are on a trajectory for major growth, ownership transition events and other ongoing capital raisings and block trades that offer the potential to steadily build positions in companies with the potential to become the next global titans.
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1. MSCI World Small Cap, the global developed market for small companies that covers 23 markets with around 4,400 constituent companies.