Is the UK stock market doing its job?
Is the UK stock market doing its job?
Stock markets serve a number of functions. Chief among these is that they allow companies to raise money, whether to finance future growth or to repair balance sheets. In the UK, many companies have been making use of this function of equity markets in the first six months of this year.
On our analysis, the number of companies raising fresh capital has leapt to around 130, far above the usual figure for a six-month period, as the chart below shows. And the amount raised (shown by the blue bars) has far outstripped the norm too.
It’s not hard to figure out why more companies are raising more money than usual. The Covid-19 pandemic saw activity shut down and revenues dry up across a large part of UK plc. Companies have needed access to additional funding – either equity or debt – during this time to ensure they stay afloat.
In terms of debt, the government has made large sums available through various loan programmes. Equity markets have done their job too, with investors buying up the new shares offered by companies in these capital raisings.
As the grey shaded part of the bar chart shows, in the first half of 2020 small and mid sized companies (worth between £50 million and £2 billion) raised about £3.8 billion. That’s been raised by 60-65 companies, comprising about 10% of the whole small and mid size equity universe in the UK.
However, we think £3.8 billion is likely to prove a drop in the ocean compared to what’s needed in this segment of the market. After all, even though lockdown has been lifted we’re still a long way from business as usual. Companies are highly likely to need more funding.
Larger firms tend to be well-known in the stock market with a tried-and-tested business model, an established investor base, and good relationships with investment banks. But what of smaller or newer companies? They may find it more difficult to access the fresh capital they need. Loans can be helpful but often just postpone the problem, with companies focused on making repayments rather than investing in future growth.
Another factor is that stock markets have been broadly rising ever since the mid-March lows. If a second wave of the virus hits, markets could easily take another turn lower. And companies would find it much harder to raise money in a flat or falling market.
We see this as a big risk. The UK is in danger of losing a number of high quality, sustainable businesses out of that small and mid size segment, with severe knock-on implications for jobs and future economic prosperity.
It’s not the stock market’s job to rescue every company in difficulty. But we see an opportunity – a responsibility even - for stock pickers like ourselves to have the chance to make good returns by investing in high quality firms, supporting them through this period, and then sharing in future growth.
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