Small-cap companies carry higher liquidity and visibility risks than their large-cap peers but Forsyth Barr broker Suzanne Kinnaird says this means some will possess positive attributes that may not be fully priced in. She talks to business editor Dene Mackenzie.
Small-cap investments are convincing growth stories, Forsyth Barr broker Suzanne Kinnaird says.
They offered profitable return generation, high-quality earnings, strong management and boards, and attractive industries.
Forsyth Barr defined small caps as companies outside of the NZX50 and under full Forsyth Barr coverage or included in the Research Insights series.
"Small caps have additional risks relative to the benchmark in the form of lack of research, coverage, visibility and liquidity. We think this also means some, less obvious, positive attributes of small caps may not be fully recognised by the market.''
Given small-cap growth opportunities could be mispriced for extended periods, Forsyth Barr focused on long-term fundamentals and confidence in growth being achieved. Investors must be prepared to look through some extended volatility, she said.
Companies preferred were those creating value over time through investment generating above cost-of-capital returns.
"We place a premium on companies that have defensive earnings or companies with high proportion of recurring or low variance in future earnings.''
Confidence in management was paramount when investing in small caps, Ms Kinnaird said.
Strong boards were necessary to drive strategic decision-making.
Strong management teams then executed those strategies.
Forsyth Barr preferred companies operating in industries with barriers to entry, where they had pricing power over supplies and consumers and there was a low threat of substitutes, she said.
Of Forsyth Barr's 18 small caps under full coverage, 10 were rated as outperform, she said.
The top four were: CBL Corporation, Evolve Education Group, Michael Hill International and Tourism Holdings Ltd.
CBL was an insurer targeting niche segments of specialty insurance markets around the world.
The company differentiated itself from the traditional insurance model through its strong focus on underwriting profitability, as opposed to having a core focus on investing premiums.
CBL generated more than 90% of its earnings outside New Zealand, making it attractive in an environment of a depreciating New Zealand dollar.
Evolve was a provider of early childhood education in New Zealand. Since listing, Evolve had pursued a "roll-up'' strategy, having increased its centre-based portfolio from 86 centres to 107 at June 30.
The company's centre-based portfolio consisted of 7158 licensed places, which captured 6% of total market share, making it the second-largest centre-based early childhood education provider in New Zealand.
In addition, Evolve expressed interest in working with developers to establish new leasehold centres that would probably result in lower setup and acquisition costs and provide organic growth through the improvement in child occupancy rates.
Michael Hill International operated a specialist retail jewellery chain.
The company had a large store base in Australia (168 stores) and New Zealand (52) and a growing store base in the United States and Canada.
It had two key growth opportunities through footprint expansion and its new brand, Emma & Roe.
While uncertainty about the company's tax dispute with New Zealand Inland Revenue was an overhang on the share price in the short term, in the longer term there was confidence management would be able to execute its growth plans.
Tourism Holdings was the largest retailer motorhome rentals operator in Australia and New Zealand.
It also owned a motorhome rentals business in the US and operated several other tourism businesses in New Zealand, including Waitomo Caves.
The management team and board had done an "outstanding job'' turning the company around through proactive decision-making, clinical restructuring and focusing on return on capital.
Key features of the positive investment case included a favourable backdrop with above-trend tourism growth likely to continue for at least two more years given the boost from aviation capacity.
A strong balance sheet gave the company the ability to expand.
