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Top Smaller Company Stocks for Growth Investors

Smaller companies were the winners from yesterday's Budget. Here are two AIM-listed firms and three top-rated funds to play the small-cap space

David Brenchley 23 November, 2017 | 3:07PM

Wednesday’s Budget from Chancellor Philip Hammond was kind to smaller companies, with a number of bigger names, notably the FTSE 100 and 250 housebuilders, seeing sharp falls.

The Budget should benefit small and medium-sized businesses

UK technology companies were the biggest beneficiaries, with bundles of cash earmarked for knowledge-based businesses, artificial intelligence and research & development for electric and autonomous vehicles.

“The investment into technology in the UK should give a boost to the country’s growing technology sector, which is primarily full of smaller companies,” says Adrian Lowcock, investment director at Architas.

Other areas included a housing overhaul, cash for councils to fund high investment projects, innovation to transform productivity in the construction sector and the extension of the National Productivity Fund.

While these longer-term structural reforms will take time to work through, adds Lowcock, they should benefit smaller and medium-sized businesses.

For those looking to gain exposure to smaller listed firms, these two stock picks and three top-rated funds could do just the trick.

Footasylum (FOOT)

Retail stocks are out of favour. UK consumer spending power is being limited by negative real wage growth and bigger players like Next (NXT) and Marks & Spencer (MKS) are struggling.

But Richard Bullas, manager of the Morningstar Bronze rated Franklin UK Smaller Companies fund, says the best way to play the sector is to find those that are on a “growth track”. “We try to stay away from the mature stocks where they’re trying to eke out 3-4% sales growth.”

Bullas recently took part in the initial public offering of footwear retailer Footasylum. Run by the team that had success with JD Sports (JD), Bullas says it’s on a store rollout plan and has aspirations to take its current 55-shop portfolio to 150 in the next five years.

The popularity of athleisure apparel is fast growing, as shown by the success of companies in the sector JD and SuperDry (SGP). Those two stocks are currently up over 800% and 200% respectively in the past five years.

While Footasylum is later to the party, Bullas still sees it as “a big growth area”. It’s solely UK-focused currently, but he foresees a similar path to JD and an expansion into Europe once its UK plan is in place. “They’re already generating a little bit of overseas interest through the website without pushing it or marketing it.”

At 201p currently, Footasylum’s share price is trading 6% above its flotation price three weeks ago.

Strix (KETL)

It’s somewhat of a cliché, but some of the best investments can be the dullest-sounding. Strix is another new entrant to the stock market, having listed on AIM in early August. It makes heating elements for kettles.

While Luke Biermann, manager of the Schroder UK Dynamic Smaller Companies fund, admits it’s a pretty dull business, “what’s interesting here is that they are absolutely dominant”.

Strix has a market share of over 70% in the UK, US and Turkey and over 50% in China. On Tuesday, it boasted of having surpassed the sale of 2 billion products worldwide.

The growth opportunity here, says Biermann, is in through emerging markets and in the US.

As emerging markets become more affluent, consumers demand better-quality products, he explains. Strix has the biggest and most efficient production facility, meaning it produces better products that are cheaper to purchase than its competitors.

In the States, there is a healthy living trend that is pushing consumers from coffee towards tea. While kettles remain rare across the pond, it makes controls for ready-to-go hot water taps, which is “penetrating quite nicely”.

Having floated at £1 per share, Strix opened for trading at 134p and is currently 6% higher at 142p.

Top Rated Smaller Companies Funds

Clearly smaller companies having more potential for growth than their larger-cap counterparts, but they also come with more risk. It’s important to do plenty of research if you’re investing in individual shares as you can lose capital.

It’s arguably more advantageous to outsource the stock picking duties to an expert fund manager that can give you more diversification and devote much more resource to identifying the top small-cap stocks.

We share one open-ended fund and two investment trusts have four-star performance ratings and Morningstar Analyst Ratings of Gold.

Old Mutual UK Smaller Companies

Managed by Dan Nickols, Old Mutual UK Smaller Companies has had one of its best years in 2017 and is up 35% in the year to 31 October.

Nickols looks for companies able to grow earnings faster than the market average; that have scope to generate a positive surprise; or that have the potential to be re-rated relative to the market. Morningstar analyst Simon Dorricott says he has a pragmatic approach to valuations and the fund is skewed towards high-growth names.

That culminates in a portfolio dominated by highly valued stocks like Fever-Tree (FEVR), boohoo.com (BOO) and Blue Prism (PRSM).

Standard Life UK Smaller Companies (SLS)

Managed by the experienced Harry Nimmo, this trust is the top performer in the Association of Investment Companies’ (AIC) UK Smaller Companies sector over 10 years. It’s returned over 400% in share price terms in that period.

Morningstar analyst David Holder says the central premise of the fund is to “buy tomorrow’s larger companies today”. That’s shown by its ability to run its winners.

Dubai-focused NMC Health (NMC), the second largest holding, graduated to the FTSE 100 in September. It’s gone from being a £1.5 billion company two years ago to almost £6 billion today.

BlackRock Smaller Companies (BRSC)

Following closely behind Nimmo’s trust is BlackRock Smaller Companies, managed by Mike Prentis. It’s returned 368% over the past 10 years.

The companies the trust invests in must, or are expected in future to, satisfy five key criteria: quality management, strong market position, cash generation, a prior record of earnings-per-share growth, and a strong balance sheet.

Holder says Prentis is “an extremely capable pair of hands”. The two biggest positions in the portfolio are veterinary group CVS (CVSG) and pharmaceuticals company Dechra (DPH).

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

Securities Mentioned in Article
Security NamePriceChange (%)Morningstar
Rating
BlackRock Smaller Companies Ord1,296.00 GBX-0.08
Blue Prism Group PLC1,133.00 GBX-5.74-
boohoo.com PLC182.50 GBX4.58-
CVS Group PLC1,055.00 GBX1.34-
Dechra Pharmaceuticals PLC1,987.00 GBX-1.68-
Fevertree Drinks PLC1,956.00 GBX0.20-
Footasylum PLC Ordinary Shares203.50 GBX0.00-
Franklin UK Smaller Companies W Acc2.57 GBP-0.02
JD Sports Fashion PLC328.90 GBX-0.48-
Marks & Spencer Group PLC309.30 GBX-0.83-
Next PLC4,345.00 GBX-1.34-
NMC Health PLC2,868.00 GBX-1.10-
Old Mutual UK Smaller Coms A GBP Acc524.67 GBP0.12
Standard Life UK Smaller Co. Ord486.00 GBX-0.41
Strix Group PLC136.38 GBX0.65-
SuperGroup PLC1,919.00 GBX0.52-
About Author David Brenchley

David Brenchley  is a Reporter for Morningstar.co.uk