The UK smaller companies market is both the cheapest and best performing in the world, new research from Abrdn has revealed.
The analysis of Britain’s smallest listed businesses comes as speculation over the Budget have left many AIM stocks sliding, thanks to rumours of a proposed repeal of inheritance tax relief on the junior market shares.
Partially due to rumours that tax changes might hit the smaller companies sector, Abrdn’s analysis found that the UK and Europe are the two regions where valuations are lowest compared with their historic average and therefore the two are the ‘cheapest’ regions.
UK small cap companies now trade at just a 16 per cent premium to the entire country’s market (using a 12-month forward price to earnings ratio), significantly below the 37 per cent average premium UK smaller companies have traded at over the past 10 years.
Despite these cheap prices, the UK is actually smashing other regions when it comes to the performance of its smaller companies sector.
This outperformance also stands up when compared to the FTSE 100 – Year-to-date, the UK small cap index is up 11.1 per cent to the FTSE’s 10.5 per cent, or 20.5 per cent to 12.9 per cent over the last year.
However, this trend doesn’t hold up beyond the last year: The UK small cap market is still down two per cent over the last three years, and is up only three per cent in the last five.
The path ahead for UK small companies
Looking ahead, and things also seem pretty rosy for UK small companies, as Abrdn data revealed UK small companies are forecast to grow their earnings by 16.4 per cent and 9.9 per cent in 2024 and 2025 respectively.
Meanwhile, British medium and large businesses are forecast to grow earnings by much less: 5.9 per cent and 5.7 per cent respectively over the same time frames.
British small caps have also historically outperformed the FTSE 100 following a rate cutting cycle, with research from Berenberg showing that in the year after an interest rate cut, the valuations of UK smaller companies historically grew by 9.3 per cent on average, compared with just 6.5 per cent for the FTSE 100.
“Smaller companies have been an asset class to have exposure to over the long-term, given the attractive returns that have been generated, as well as diversification benefits when included as part of a broader portfolio,” said Abby Glennie, fund manager at Abrdn.
“Holding for longer periods, such as five years, can help investors navigate volatility, but we see a particularly attractive entry point into UK smaller companies now. This is down to current valuations, both absolute and relative to larger companies, as well as the ongoing strength of company balance sheets and reporting from our investee companies.”
