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European smaller companies: Investing for today and tomorrow

European smaller companies: Investing for today and tomorrow
Credit: Unsplash

If the past two years have taught us anything, it is that change is not only inevitable but has become increasingly unpredictable. 

The arrival of Covid-19 changed our way of life, from how we work to the way we conduct business and leisure. Though vaccines have restored some semblance of normal life – dubbed the 'new normal' – the fallout has left behind a market riddled with uncertainty.

Variants continue to threaten global growth, global supply chains are faltering, inflation keeps grinding higher, central banks have begun to withdraw monetary support, and some have already started raising interest rates. 

The outbreak of war in Ukraine is also now a dominant theme driving the markets and is being factored into investment decisions. 

Amid all this, investors have been trying to determine how all this affects their portfolios and how they can best navigate this testing market environment. 

With noise and uncertainty now part of the new normal, for investors, clarity is more important than ever.

Looking to the European market as a case study, particularly the small-cap arena, the market is geared to global growth. 

It is this market that provides a strong base for the young innovative companies in Europe that are helping to provide solutions in manufacturing, health care and technology, including e-commerce.

Europe is a stock-picker’s market and despite the war a global recovery will still hopefully be slowly underway, which presents an excellent opportunity for European investors to find companies with sound business models that are aiming to grow their business within the next three to five years.

European small caps are also at the forefront of sustainability. Investors are becoming increasingly eco conscious, from the food they eat to the investments they hold. 

While smaller companies can often be less focused on presenting what they do in these areas and more focused on their business operations, many are playing a vital part in the green agenda in the longer term. 

The small-cap arena

In continental Europe alone there around 2,500 small-cap stocks, a vast universe of diverse holdings for investors to choose from. 

Their key benefit is that smaller companies provide investors with the opportunity for faster growth when compared to their larger counterparts.

Currently, small caps are trading at a slight discount compared to large caps, offering investors lower valuations for greater growth.

Smaller companies are less prone to passive investing exchange-traded funds and therefore trade more in line with their fundamental operating performance and intrinsic value. 

Yet despite this, the vast universe of less well-covered stocks leads to a less efficient market, that creates an opportunity for active investors to outperform their benchmark, which many funds focused on larger companies have historically struggled to do.

Small caps are also the major beneficiary of merger and acquisition activity. While bigger deals may capture the headlines, the vast majority of deals are actually within the small to mid-cap market.