Chart of the Week
Small Caps (defined as companies with market capitalisations below €2bn) are in positive territory year to date (+8% for the MSCI EMU Small Cap Net Return) but their performance continues to lag that of Large Caps (market capitalisations above €8bn). The valuation gap between Small and Large Caps has reached its highest level for two decades. Between 2003 and 2018, Small Caps traded at a premium but have since progressively derated and currently trade at an average discount of 14% (at end August 2023).
Overall, Small Cap financial results remain strong: average annual earnings growth was +8.6% between 2019 and 2022, higher than the +7.5% achieved by Large Caps.
Rising rates have weighed disproportionately on the segment. This is partly explained by the fact that growth stocks, whose higher valuation multiples are more sensitive to interest rates, represent a significant portion of the Small Cap universe. More restrictive financing conditions can also be more problematic for smaller companies although this risk only affects those companies with high levels of debt. More generally, funds invested in Eurozone Small and Mid Caps have seen significant outflows over the last few years (€2,7bn of net redemptions in 2022 alone)1. This reflects investors’ caution in the face of an uncertain economic outlook, with Small Caps seen as riskier than Large Caps.
Despite short term uncertainty, Small Caps on average are currently trading at particularly attractive valuation multiples. The record discount seems hard to justify given the intrinsic qualities of many of the companies in this segment.
Written on September 22, 2023. This is not an investment advice. Opinions subject to change.
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