‘SMID’ is beautiful… despite France
Laurent Denize, Global Co-CIO, ODDO BHF AM.
“It is time to re-invest in the Small and Mid-Caps segment with a preference for Mid over Small. EPS growth momentum is better for pretty similar valuation discounts. “
Europe faces significant structural challenges that impact its productivity compared to the US. Market fragmentation and regulation, a high proportion of small businesses, elevated taxes and lower R&D spending are some of the key contributors to this disparity. However, since the global financial crisis, these downsides have not worsened; in fact, many have become less detrimental.
European small firms make up a significant part of the corporate sector, especially in comparison to the US. American companies with 250 employees or more account for 59% of business employment, compared to 43% in Germany and 48% in France. Small businesses often allocate resources less efficiently than larger firms and are slower to adopt new technologies.
Investors are right to ask: can small companies capture the forward value created by the artificial intelligence revolution? We aim to demonstrate that, by definition, small companies will participate in any Schumpeterian evolution, as progress eventually spreads out to the entire economy.
The next question is: when? We believe the time has come to reposition for broader value creation, and we see early signs of this in the new positive earnings per share (EPS) trend. But first, let’s delve into some theory.
Fama and French, among other researchers, have shown that small-cap stocks tend to outperform large-caps in the long run. Historically, investors have been willing to pay a premium for small and mid-cap stocks, recognising their higher growth potential compared to large caps.
However, in times of heightened macroeconomic uncertainty like today, investors tend to prefer the relative safety of blue-chip stocks. Smaller stocks often face risks related to their balance sheets, have high sector or geographic concentration, and may lack the scale to absorb significant business shocks.
This largely explains why European small and mid- caps – equities with a market capitalisation between EUR 200 million and EUR 10 billion – have underperformed their larger counterparts in recent years. As of the end of May 2024, small caps have continued to lag behind large caps in all major investment regions, with a 300-basis points underperformance in Europe and a 750-basis points in both Japan and the US.
Nevertheless, we believe that small and mid-caps offer higher long-term earnings growth at a discount and should perform better in the second half of 2024, particularly in Europe.
