There are big risks involved with investing in individual stocks, however, and especially those lower down the market cap scale. Even if an investor finds a cheap company with untold growth potential, unforeseen circumstances such as a change in management or a natural disaster could derail it.
There were countless reasons why FTSE 100 giant BP was a good investment in 2010, but the Gulf of Mexico oil spill resulted in huge capital losses and a dividend cut. This shows just how risky investing in a multinational company can be, let alone a less liquid small cap.
For this reason, most experts recommend that investors should only hold as much as they can afford to lose in stocks. A number of star managers, many of whom dedicate every waking hour to company research, lost big when BP was in free-fall – to assume we can do a better job with limited time and resources is asking for trouble.
That is not to say investing in stocks should be completely avoided: holding a basket of equities alongside collective vehicles such as funds, investment trusts and ETFs can give your savings an added kicker if you get your choices right.
With this in mind, FE Trustnet asked Andrew Strathdee (pictured), manager of the four-crown rated Baillie Gifford British Smaller Companies fund, to highlight three UK small cap stocks whose long-term prospects he and his team are particularly excited about.Abcam
Strathdee is a big fan of Abcam, one of the largest holdings in his fund. The company, which has a market cap of just under £1bn, distributes antibodies to the scientific research community, both in the public and private sectors.
"It has gained an industry-leading position by harnessing the benefits of a web-based distribution platform," said Strathdee. "Clients supply data that characterises the antibodies that Abcam distributes and this has built up a bank of information that aids customers when choosing products, allowing Abcam to build marketshare in what is a rapidly growing market."
"I believe that this market is likely to grow quickly for many years and that Abcam is well positioned to benefit from its now well-entrenched position."
The company has already had a good run in recent years, but Strathdee thinks the story still has much further to run.
"The longevity of the growth opportunity is not reflected in the current valuation," he said.
Abcam, which is currently trading on a price-to-earnings [P/E] ratio of 30 times, has returned more than 50 per cent over a three-year period, but as the graph below shows, it has arrived at this figure with a great deal of volatility. It is currently yielding 1.57 per cent.
Performance of stock over 3yrs
Source: FE Analytics
It is a popular stock among UK small cap fund managers, appearing in the top-10 holdings of four funds in the IMA unit trust and OEIC universe. Aside from Strathdee, among its biggest admirers are Artemis UK Smaller Companies and Standard Life UK Smaller Companies.
Renishaw
Renishaw has recently been promoted to the FTSE 250, but with a market cap of £1.3bn, it is still a part of the Numis Smaller Companies (ex IT) index – the most popular benchmark among UK small cap managers.
It too has had a good run over the last three years or so, with high levels of volatility, but Strathdee remains confident that it will continue to expand over the long-term.
"Renishaw is an engineering company that is a global leader in the field of high-precision measuring probes," he explained.
Performance of stock over 3yrs
Source: FE Analytics
"The business has little visibility and is subject to short-term variations in demand; however, while the market obsesses about such volatility in performance, the business grows rapidly across cycles and currently faces a prolonged period of exceptional growth, driven by greater use of automation and robotics in manufacturing."
"Because of the high level of short-term volatility in the business, the valuation does not reflect the long-term growth that Renishaw is likely to achieve," he added.
Renishaw is trading on a P/E ratio of 19 times and is yielding 2.5 per cent. This healthy yield has led to it becoming a popular stock with income-focused UK equity funds including John McClure’s Unicorn UK Income, though he does not currently include it as a top-10 holding. Three funds do hold the stock in their top-10, including the five crown-rated Liontrust UK Smaller Companies portfolio.
Shaftesbury
Strathdee points to property company Shaftesbury as another stock he likes, and a shining example of one that has and will continue to steadily create value over a long period of time.
"The business owns property in the West End of London," said the manager. "The model is to build up a high concentration of properties in an area and then work to raise the quality of the environment, which in time pushes up rents."
"This model has been successfully deployed in, for example, Carnaby Street, Covent Garden and Chinatown. With scope to expand into new areas, I believe that Shaftesbury will continue to deliver increases in value for shareholders for many years to come."
FTSE 250-listed company Shaftesbury has delivered much more stable performance than Strathdee’s other choices over the last three years.
Performance of stock over 3yrs
Source: FE Analytics
Shaftesbury has a market cap of £1.5bn, is currently trading on a P/E of 11 times and is yielding just over 2 per cent.
Threadneedle Pan European Smaller Companies is one of three IMA funds that hold it in their top-10.
Strathdee only took over the Baillie Gifford British Smaller Companies fund earlier this year, but he has been on the firm’s equity desk for almost two decades. Prior to Strathdee, it was headed up by Douglas Brodie.
The £222m fund has been one of the standout performers in the IMA UK Smaller Companies sector recently, boasting top-quartile returns over three, five and 10 years. It has also beaten its FTSE Small Cap ex IT index benchmark over these periods.
Performance of fund vs sector and benchmark
| Name | 1yr | 3yr | 5yr | 10yr |
|---|---|---|---|---|
| Baillie Gifford - British Smaller Companies | 30.24 | 77.62 | 139.44 | 319.36 |
| IMA UK Smaller Companies | 29.49 | 57.51 | 113.24 | 195.44 |
| FTSE Small Cap Index (ex IT) | 42.37 | 64.59 | 105.44 | 105.18 |
Source: FE Analytics
The fund requires a minimum investment of £1,000 and has ongoing charges of 1.5 per cent, making it one of the cheapest options in the IMA UK Smaller Companies sector.
