Dunedin Smaller Companies manager Ed Beal has said quality small and mid-cap stocks look “fully valued” following a strong run in recent years.
The manager of the Aberdeen-run trust, who typically takes a more conservative approach than many of his small-cap peers, said valuations of stable, less cyclical companies are now in danger of becoming too rich.
The post-crisis bull market in equities has seen the FTSE Small Cap index rise 69 per cent and the FTSE 250 rise 80 per cent over the five years to August 17, compared with a 24 per cent rise for the FTSE 100.
More recently, the mid-cap index – home to many of the stocks in which Mr Beal invests – raced away again. Both the FTSE 250 and FTSE Small Cap index have outperformed the blue chip index year to date by several percentage points.
“I think all quality is looking more expensive, generally. I can look at the small-cap market and say it’s cheap relative to other asset classes, but then [those asset classes] look quite expensive,” Mr Beal said, speaking prior to the sharp falls in the FTSE seen on August 21 and 24.
“Small caps are still on a discount [to the FTSE 100] but we have quality companies in our portfolios, and across the board, quality looks fully valued.”
In contrast to this strong capital growth, Mr Beal said some firms’ dividend payouts have taken a hit as companies seek to give themselves more room for manoeuvre.
“We have had some exceptional dividend growth for the past three or four years, and you might expect that to come a bit later in the cycle. It might be time to think about more normalised growth and maybe cuts in the future,” Mr Beal said.
“We have one or two companies in the portfolio that have reduced their dividend which has given them more financial flexibility.
“It’s probably fair for them to pay a dividend in the future that comes out of earnings rather than debt.”
Elsewhere in the portfolio, a strong run for bakery Greggs has seen the manager reduce his position, but a profit warning at printhead manufacturer Xaar enabled Mr Beal to buy on weakness.
In the three years to the end of June the £126.8m trust’s NAV return has underperformed that of the Small Cap index, with a return of 78.9 per cent compared with 88.3 per cent for the index.
Mr Beal said part of this underperformance was due to not holding Thomas Cook, which cost 140 basis points.
“Sometimes it’s the things you don’t own that lead to underperformance, but you wouldn’t expect us to hold a company like Thomas Cook,” the manager said, adding that he saw it as a cyclical business not suited to his cautious stance.
He said Oxford Instruments, which manufactures technology tools, had been a “sizeable negative contributor” on a three-year view, but had been one the trust’s best performing companies over five years.
