* Cheap central bank cash filtering down to smaller firms
* Investment in smaller companies slowly rising
* Earnings, valuation, M&A to drive outperformance
* Large/small cap correlation falling
By David Brett
LONDON, Feb 25 Shares in Europe's smaller
companies are starting to attract fresh investors and should
outperform larger firms this year as the continent's relative
minnows belatedly felt the impact of central bank stimulus.
Historically, small and mid-sized companies (SMIDs) -- with
a market capitalisation of $500 million to $5 billion -- have
outperformed the blue chips, taking off as soon as equity
markets rise, because their better growth prospects and exposure
to a broader array of business areas offer investors the chance
of bigger gains.
This time, though, that outperformance is only just
starting, as the unprecedented stimulus from global central
banks -- which has lifted investor confidence and gradually
driven them out of lower-risk assets -- is only gradually
filtering down to the smaller firms.
"Investors had all this cash on the side and wanted to plug
it straight into the market ... which inevitably meant trading
into the big names because that is where the liquidity is," Max
King, investment strategist at Investec said.
"(But) investors are now saying: 'I am in the market let us
put on some orders in some SMIDs and we can finance that by
taking some out of our (blue chip index) ETFs'."
In the final six months of 2012, 5 billion euros ($6.6
billion) flowed into European equities, with the lion's share
going to the fewer than 1,000 large listed companies and just
1.2 billion euros invested in the 5,200 small caps, according to
But, with the EuroSTOXX 50 and other blue chip
indexes hitting multi-year highs and no longer looking so cheap,
that trend has started to turn. Regional numbers from data firm
Markit shows money flowing into Exchange Traded Funds invested
in British and German small and mid-caps, while those focused on
large caps have witnessed outflows so far in 2013.
The divergence in price performance between European large
caps and smaller companies has become stark since the start of
February, according to a daily correlation chart. The MSCI
European small and mid-cap index is up 3 percent this month
, while the MSCI European large index has lost
0.2 percent, after the two gauges largely kept
pace with each other in the previous seven months.
Although the European economy remains sluggish, expectations
of recovery in the second half of 2013 are another reason
investors are looking at the smaller companies.
"Small caps are the bellwether of the economy and the recent
outperformance reflects the improved prospects ... This will
continue as long as the economic outlook is brighter," Simon
Maughan, strategist at Olive Tree Securities, said.
Turning to the UK, he said that fuelled by central bank
money printing, and with fixed income investment looking
unatttractive due to ultra-low bond yields and with hints of
economic recovery, the UK small cap index should test
its record high at 4,207, reached in 2007.
That would represent a 14 percent gain from current levels,
while the FTSE 100 is just 8 percent off its all-time high of
6,798 points reached in September 2000.
The case for SMID outperformance is also backed by earnings
expectations, valuation and merger and acquisitions activity,
with the combined value of deals worth less than $500 million
recently hitting its highest since June 2011.
"Larger European companies ... are now looking more fully
valued, so the potential for further relative positive
performance in Europe now looks more likely in smaller
companies," Edward Bland, head of research at Duncan Lawrie
Private Bank, said.
"This is set against a background when smaller companies'
earnings growth is starting to run faster than their larger
Earnings among smaller European companies are expected to
grow around 40 percent over the next 12 months, compared with a
miserly 5 percent for the larger caps, according to Thomson
Reuters I/B/E/S estimates.
A quarter of small and mid-cap stocks still trade at a
market value below the stated worth of the assets on their books
compared with 15 percent of blue chips, Starmine data showed.
But none of this means investors should take a scattergun
approach to investing in the area.
"What we look for in this environment, is non-consensus
plays with significant rerating upside," Eduardo Lecubarri, Head
of Small/Mid-Cap Strategy at JPMorgan, said.
Lecubarri sees such opportunities in Europe within what he
labels "Affordable Growth" stocks, whose earnings are expected
to grow at least 10 percent and that trade below 14 times
Another option is to seek "Quality Value", or companies
which trade below 10 times earnings but have positive free
cash-flows, good balance sheets and are able to benefit from
His top picks include UK high street retailer Debenhams
, developer Quintain, asset manager Jupiter
and Spanish television company Antenna 3.