DIY Investor Magazine
|
June 2017
20
GROWTH AT THE RIGHT PRICE, GROWTH
AT A REASONABLE PRICE
Professors Elroy Dimson and Paul Marsh, the
academics behind the FTSE 100 and Numis Smaller
Companies Index (NSCI),make a compelling case for
investing in smaller companies over the long-term.
In their 2017 NSCI Annual Review, Dimson and Marsh
looked at the performance of a number of equity asset
classes since 1955: If you’d bought the FTSE All-
Share you would’ve gained a handsome 968%; the
MSCI mid-cap index would’ve handed back 2,870%;
and the NSCI? 6,067%. Needless to say, the stark
outperformance of small-caps over large-caps is
undeniable.
If we look at discrete 10-yr periods, i.e. 1955 to 1964,
and so on, the evidence continues to be compelling:
in the six periods to 2015, smaller companies
outperformed in five of them. The exception was 85-94,
coinciding with an explosion of easily available credit
that enabled larger companies to boost their growth,
somewhat synthetically.
So why do smaller companies outperform over the long
term?
There are a number of theories. Aside the more obvious
factors of strong earnings growth and greater corporate
emphasis on innovation, which engenders the ability to
capitalise on market opportunities more effectively, there
is also the ‘neglected effect’.
The complex operations of larger companies are usually
covered by a suite of analysts. It means the market – as
a pricing mechanism that represents all of a company’s
publicly available information – tends to be well served,
reflecting the corporate’s fundamental worth with
relative accuracy. Smaller companies usually have
far fewer analysts covering their operations, meaning
there are greater opportunities for a fund manager to
spot anomalies – mismatches between a company’s
prospects or performance and its share price.
Our ability to then choose the strongest companies
draws from the team’s extensive experience in picking
stocks, at over 74 years collectively. But simply
allocating to smaller companies or even picking great
stocks is insufficient – our belief is that you need to
buy them at an attractive entry price to generate strong
returns over the long term. It was Benjamin Graham, a
man often referred to as the ‘Father of value investing’,
who said: “Buy not on optimism but on arithmetic.”
We are growth investors but we apply value principals
so as not overpay for the above-average growth of
earnings we are seeking to find. This investment style is
known as growth-at-the-right-price, or GARP.
As we have written on before, structural or ‘secular’
growth stories also remain an important part of our
portfolios. In a world where economic growth is low and
fragile we have been looking to firms that are exposed
to isolated growth trends – where the drivers of their
returns isn’t correlated, or at least very lowly correlated,
to the wider macro-economic cycle. Brexit uncertainties
and others abound, this has proved a sensible strategy
in recent years.
To highlight some of our structural growth names:
BURFORD CAPITAL
Litigation can be a long and expensive game. For law
firms, with many cases likely running at any one time,
cash can get tied up and be prevented for use in the
growth of new business. The accounting treatment in
the recognition of this cash-flow is not favourable either,
and traditional finance doesn’t like litigation assets so
bank lending is often hard to obtain. Burford specialise
in bridging this gap.
Structural returns come from their low correlation to the
market or business cycle. They are also very picky in
selecting assets – usually around 10% of cases offered
– and yet they have managed to generate very strong
rates of return on their investments.
