The small cap conundrum

With so much uncertainty in the markets, it feels like there is no place to hide – especially, it seems, for small businesses in South Africa, raising concern for the outlook of small cap investments.

Anthony Sedgwick, Fund Manager of the Nedgroup Investments Entrepreneur Fund addressed this issue at the recent Nedgroup investment Summit – an annual event attended by over 800 industry professionals.

“Times have been tough for small businesses and the South African economy as a whole - But it looks like it will remain that way. Periods like this expose the businesses lacking the resources to persevere and we have seen strong recent evidence of this” he says.

In spite of that, Sedgwick is optimistic about valuations. “The good news is that valuation are quite attractive at the moment. A lot of small businesses are trading at good value – between 6-8 times profits and often also at attractive dividend yields. The question is, can they maintain or grow those profits?” he says.

The macro-economic outlook remains bleak with very low business and consumer confidence and weak GDP growth. Unless these reverse, Sedgwick believes small business in South Africa cannot start their recovery.

“We need a reasonably stable exchange rate, political stability and economic policy certainty. This combined with accelerating and broad-based economic growth, a rising capital investment cycle and improved consumer confidence. For the time being the fact is that these factors, are absent or worse, deteriorating.

So what should you be doing regarding small cap exposure?

According to Sedgwick, assuming that South Africa still has a business cycle and is not headed down the path of terminal economic decline followed by Zimbabwe or Venezuela, then there is still great opportunity in the small cap space.

“Valuations are attractive, but growth prospects are unexciting or very uncertain. There is practically zero investment interest in the space currently and pessimism is high. The question is: will the South African economic cycle recover? Only time will tell. In the meantime we remain defensively positioned in the space in attractively priced businesses with adaptable, entrepreneurial, shareholder-centric management and which offer products or services that will endure” he says.

ENDS