Barclays strategists say UK and European small and mid caps (SMID) offer an attractive opportunity for long-term investors after they sharply underperformed large caps since the banking wobbles in March.
The MSCI Europe Small Cap Index is down 20% from its 2021 highs while the large cap equivalent is pretty much back at its highs. And as for the UK, the mid-caps are in focus, with the FTSE 250 down around 20% versus the FTSE 100 from the relative highs of two years ago.
This underperformance has been by "more than is implied by fundamentals", the Barclays team said, and now looks "overdone".
It is a divergence in performance that has left defensive equities "looking historically expensive and small caps looking very cheap".
In terms of valuations, price/earnings and price-to-book ratios are close to the bottom of the historical range in both absolute and relative terms.
Although small caps are high beta, meaning more volatile in terms of investment outcome, their performance "already looks too depressed versus the relative resiliency in the economy and earnings, and fairly aligned with the tightening of financial conditions".
The small caps underperformance "seems out of place", the strategists said, in comparison with the rebound in cyclical versus defensive stocks in the last six to nine months, and the recent rebound in 'growth' versus 'value'.
It was noted also that over the long run, small caps have steadily outperformed large caps.
A group of 10 of the bank's higher-conviction SMID stocks were highlighted, which were all seen as being supported by organic growth narratives and/or M&A potential.
The UK names in the SMID basked are OSB Group PLC (LSE:OSB), Harbour Energy PLC (LSE:HBR), Howden Joinery Group (LSE:HWDN), WH Smith PLC (LSE:SMWH), Tate & Lyle PLC (LSE:TATE), Coca Cola HBC AG (LSE:CCH) and IMI PLC (LSE:IMI).
OSB, the UK specialist bank, has "high ROE, low cost-income, largely secured loan book and sector-leading capital returns"; Harbour Energy for "at least 40% free cash flow yield in 2023 and 2024"; Howden Joinery, the UK kitchens retailer, "trading at depressed multiple despite secular share gains"; WH Smith, a play on "travel recovery and new site growth to drive multi-year compounding"; Tate, the specialty ingredients group, for a "valuation gap set to close as growth sustainability and earnings quality improves"; Eastern Europe drinks bottler CCH as it has "a long growth runway trading at significant discount to peers due to Russia exposure"; and IMI, for "upside risk to consensus estimates, particularly from FY24 onwards, as the flow control industry cycle remains higher for longer".
Continental names include Delivery Hero (ETR:DHER, OTCQX:DLVHF), liked for "accelerating growth, margins improving and FCF breakeven firmly in sight – potential to be the ‘next Uber’"; Tecnicas Reunidas, an E&C company "likely to benefit from energy capex resurgence trading at sub 4x EV/EBITDA"; D’ieteren, an automotive holding company that "benefits from ADAS transition and an aging car parc trading at c40% discount to NAV".