- Small- and mid- cap names historically outperform their large cap peers following a recession.
- SMID cap names are looking very cheap at the moment, offering potential for big gains.
- These are the top 9 stocks in Trevor Gurwich’s portfolio set to soar on an economic recovery.
- Visit the Business section of Insider for more stories.
The vaccine rollout is now in full swing, and countries are gradually preparing to reopen their economies. And this is giving small- and mid- cap companies around the world an opportunity to “spring” back, which offers massive opportunities to investors, according to Trevor Gurwich, portfolio manager of American Century Investment’s global small cap equity fund and its international opportunities fund.
There’s historical precedent to this arguement. Following every major crash of this century, these so-called “smid-cap” stocks have outperformed their larger cap peers. For example, following the 2008-2009 financial crisis, the small cap universe rocketed up over 106%, while the large caps “only” gained about 78%.
The boost to the SMID cap market following the post-coronavirus recovery should follow suit, Gurwich said.
Small- and mid-cap companies are inherently closely linked to the real economy and real consumer activity and therefore, they suffer more during times of recession, and gain more in times of economic expansion.
“We have ample fiscal and monetary stimulus, and there is a real interest in politicians to get small businesses up and running again,” he said, adding that “you’re pretty well set up for another good year in small-cap universe.”
This crisis has caused huge asset price inflation for growth stocks, with investors focusing on several “market darlings”, neglecting the smaller cap names, he said.
But a larger company is not always necessarily a “good” company. Looking at the fundamentals of small caps, they’re actually growing faster than the larger caps, Gurwich noted.
“In 2021, consensus is expecting about 27% growth for small caps, which is actually pretty strong and good. When you take a look at the relative valuations, in terms of the spread of PE ratios, you’re looking at almost a one to two standard deviation spread in PE ratio,” he said.
Amongst the 10,000 names in the SMID cap universe, one should look for the 1-2% that are offering growth and inflection, Gurwich said. These inflection points are inefficiently identified by the market, meaning they offer ample returns if played correctly, he noted.
“If you focus on those inflection points, you take advantage of the company as it begins to grow, but more importantly as it becomes more discovered and as it begins to rerate,” he added.
The fund operates on the philosophy that earnings drive valuations, meaning over time, investors derive alpha through a stock selection that correctly identifies these inflection points, which leads to a change in company fundamentals and therefore a higher valuation.
Inflection points can be a whole host of factors – most obviously, a new product or new management team. But, M&A opportunities, divestitures and geographical expansions are also big factors for the SMID spaces. Indeed, around 90-95% of all M&A takes place with the sub $5 billion market, he said.
A good example of this is Metso Outotec, a recent merger of two Finnish minerals and mining companies.
“As they combine forces, sales forces, production forces, engineers, they’re able to extract a lot of synergies. They’re also able to extract a lot of revenue and cost synergies basically to help power their cash flows going forward. That inflection there is really the integration of those two companies,” he said.
The vaccine rollout has given governments a “route to reopening”, as populations gain herd immunity and are able to gradually return to more normal activity safely. This will allow those businesses that have been hardest-hit by national lockdowns, such as cafes and restaurants, to hairdressers or gyms, to stage a recovery, boosting their earnings and eventually causing a re-rating.
Gurwich highlighted these nine cheap stocks in his portfolio that are best exposed to the economic recovery:
- Ticker: NYSE: BC
- Sector: Manufacturing
- Market cap: $7.11 bln
- Ticker: TSE: DOO
- Sector: Manufacturing
- Market cap: $8.49 bln
China Yongda Automobiles
- Ticker: HKG: 3669
- Sector: Automobiles
- Market cap: $2.96 bln
- Ticker: LON: FEVR
- Sector: Beverages
- Market cap: $3.96 bln
- Ticker: NYSE: WH
- Sector: Leisure
- Market cap: $5.56 bln
- Ticker: LON: WEIR
- Sector: Engineering
- Market cap: $7.12 bln
- Ticker: HEL: MOCORP
- Sector: Mining and Minerals
- Market cap: $8.51 bln
- Ticker: EBR: MELE
- Sector: Semiconductors
- Market cap: $4.74 bln
- Ticker: EPA: SOI
- Sector: Semiconductors
- Market cap: $7.25 bln