Beyond price - Smaller company prices may be at record highs but their valuations are not
The fact both the FTSE mid 250 and FTSE Smallcap indices have recently been trading at all-time highs may have seen some investors reaching for the champagne but, here on The Value Perspective, our healthy respect for the principle of mean reversion naturally inclines us to treat any sort of record peak – or indeed low – with caution.
Rather than growing more excited as share prices rise, value managers naturally become more nervous although of course, as we continually point out, it is not a company’s share price itself that matters but its valuation. In On the level, for example, we noted how FTSE 100 valuations have been significantly lower this year than in 2000 and 2007, the two other times the index has breached the 6,500 mark.
While the Mid 250 and Smallcap indices may be at all-time highs, the broader FTSE all-share is not, which suggests the FTSE 100, its other component, must be the swing factor in the equation. That begs the question – is the FTSE 100 cheap today and the Mid 250 and the Smallcap expensive? If we are honest, before we started to look more closely, we expected the answer to that would be ‘yes’.
Back in 2007, the last time the footsie was around current levels, there was a marked disparity between the valuations being placed on the UK’s 10 very largest or ‘mega-cap’ companies (Shell, HSBC, Vodafone, Glaxo and so forth) and everyone else – and particularly the Mid 250 businesses, where investors at the time were indulging in a game of ‘hunt the bid’. Is something similar going on today?
The following chart would suggest not. Running from 1993 to the present, it shows the price/earnings (PE) ratios of the FTSE 100, 250 and Smallcap indices as well as of those mega-cap stocks and you can see for yourself the large valuation differential from 2007, to which we just referred. Today, however, that is not the case and valuations across the capitalisation scale are much closer together.
Despite the Mid 250 and Smallcap indices’ all-time highs, the valuation discrepancy this time is small and indeed about in line with long-term averages. While that discovery may not quite have us reaching for the champagne ourselves at The Value Perspective, it should prove of interest to anyone who, like us, believes valuation is the biggest driver of whether or not you make money from an investment.
Fund Manager, Equity Value
I joined Schroders in 2000 as an equity analyst with a focus on construction and building materials. In 2006, Nick Kirrage and I took over management of a fund that seeks to identify and exploit deeply out of favour investment opportunities. In 2010, Nick and I also took over management of the team's flagship UK value fund seeking to offer income and capital growth.
The views and opinions displayed are those of Nick Kirrage, Andrew Lyddon, Kevin Murphy, Andrew Williams, Andrew Evans, Simon Adler, Juan Torres Rodriguez, Liam Nunn, Vera German and Roberta Barr, members of the Schroder Global Value Equity Team (the Value Perspective Team), and other independent commentators where stated.
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