The shares of small and medium-sized companies are actually well-liked on the stock market, as they offer significantly better valuations than the large blue chips in a historical comparison. "In the context of the cycles that have applied to date, now would actually be the time for a rally in the small caps," says Mathias Beil, Head of Private Banking at Hamburg-based Sutor Bank. "But the current weakness has new, different reasons." And they are permanent.
The current valuations of small and mid-caps actually offer entry levels. "Historically, the valuations of small and medium-sized companies have usually been more favourable than those of large listed companies," says Beil. "Cyclically, they always deviated once in a while, and then good buying opportunities emerged in retrospect." The price/earnings ratios of these companies are also currently much more favourable on average than those of the major players. However, a similar recovery is not to be expected immediately this time: "The cycle could end here," says Beil. And there are two reasons for this.
Firstly, the introduction of the EU Mifid II directive has meant that analyses are no longer included in the total costs of financial institutions, but must be reported and charged to customers. "As a result, many investment firms are focussing their research capacities on stocks that generate higher turnover on the stock exchange," says Beil. "Overall, the number of stock corporations being monitored has been reduced, as has the density of analyses."
For small stock corporations in particular, this means that they receive less attention, attract less attention and are also sold less actively by the large investment houses. "On the stock market, this leads to lower turnover, which makes research for a share less attractive again - a downward spiral," says Beil. "These shares become less and less visible."
Surprise potential increases for small and mid-caps
In parallel and in addition to this, a second trend is working against small and mid-caps: "The growing popularity of ETFs, index funds, is leading to a concentration of turnover on large stocks listed in the major indices," says Beil. "The more capital the ETFs accumulate, the more of the market capitalisation flows into the indices they contain and the shares listed in them. This has the same effect as the lower analysis density: Less turnover in the small ones, less visibility in the market."
This makes buying small and mid-caps less attractive for all investors who rely or have to rely on external research. "This increases the risk of investing in a black box," says Beil. "On the other hand, the low density of analyses naturally also allows companies to grow under the radar and surprise the markets with completely new success stories." In this respect, it would be premature to write off the small and mid-caps. "It will take longer to find the real gems in the future," says Beil. "But these will then offer real potential for surprises."
