JP Morgan Asset Management sees opportunity in European small cap stocks

Managers at JP Morgan Asset Management see particular reasons to be interested in European small cap equities, which continue to perform well over the long term.

Research by JP Morgan Asset Management shows that European small cap companies have provided world-beating long term equity returns, surpassing other global indices including broader European stocks on a cumulative basis over the past 20 years, as illustrated in the chart below.

european-small-caps-charts

Small cap stocks represent a huge and under-researched opportunity base. Because a smaller relative number of analysts are covering small cap stocks, this means it is a less efficient market with a broader opportunity set. Each European large cap stock is covered by an average of 17 analysts, whereas the average small cap European stock has only 4 analysts. The lower level of coverage provides an opportunity for active investors to add value by selecting the most attractive opportunities from a broad universe of over 1,500 European small cap stocks.

Contrary to popular perception, investors do not have to accept much higher risk from small caps in order to achieve their higher promised returns. In fact risk-adjusted returns from small caps have historically been much more attractive than in mid and large caps, as illustrated by the Sharpe ratios in the chart below.

european-small-caps-lower-risk

Small cap stocks have also demonstrated stronger compound annual growth rates than large caps and are attractively valued relative to their own history. The price to earnings ratio on European small caps is currently below its long-term average of 13.7x.

Finally, with improvements in the macro backdrop, for the first time in several years fund managers feel able to focus on stockpicking, rather than looking over their shoulder at an impending Eurozone crisis.

“The speed of change in the European periphery, both at the macro and the micro level, is impressive,” said Francesco Conte, co-manager of JPMorgan European Smaller Companies Trust and JP Morgan Funds – Europe Dynamic Small Cap Fund.

Conte and co-manager Jim Campbell (pictured) generally seek three characteristics when buying stocks.

Firstly, they buy companies that can demonstrate secular long-term growth. These companies tend to have leadership positions in their markets and the ability to grow earnings. Conte cites German financial services and technology company Wirecard and Italian online luxury retailer Yoox as two examples of stocks with strong organic growth and market opportunity.

Secondly, they buy companies benefiting from a cyclical recovery. In some cases, these companies used the economic recession to cut costs and become more competitive and profitable. Conte cites Irish building materials company Kingspan and Trigano, the French manufacturer of camper vans, as two shares that are poised for cyclical margin recovery.

Thirdly, they buy companies that represent a corporate restructuring story. These companies often have reorganised after a downturn to regain significant success with new management. Spanish wind turbine maker Gamesa and Italian footwear producer Geox are two stocks where new company leadership is streamlining products and operations for improved growth, says Conte.

 

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