UK small caps have struggled in recent years, weighed down by weaker investor sentiment and a lack of domestic inflows. As a result, valuations are now at historically low levels.
The asset class is trading at a forward price-to-earnings ratio of just over 10x, well below its long-term average of 14x and significantly lower than international peers. More than a third of AIM-listed businesses between £50 million and £250 million market cap lost over 30% of their value last year, despite many having strong fundamentals.
Source: Bloomberg as at 30 September 2024. P/E = Price to Earnings
While some of this de-rating reflects economic uncertainty, it also presents a compelling opportunity. Many high-quality businesses with strong growth prospects are being overlooked, setting the stage for a potential reappraisal.
Beyond the macro picture, UK small caps offer exposure to global growth themes, including fintech, software, decarbonisation, and intellectual property & content. Many companies in these sectors generate most of their revenues internationally but are valued at a discount due to their UK listings.
One example of the opportunity is Bloomsbury Publishing, which has diversified beyond traditional books into a subscription-based academic publishing business and capitalised on the rising demand for audiobooks and e-books. Despite being headquartered in the UK, 75% of Bloomsbury’s revenues come from international markets. Many UK small caps are similarly well-positioned, particularly in the AIM market, which has long been home to innovative, high-growth businesses.
With UK small caps still out of favour, investors have an opportunity to access structural growth at a significant discount, a theme increasingly recognised by corporate buyers.
You don’t need to look very far to be confronted with negative headlines and stories of broken Britain. But, maybe it’s time to change the narrative, take a closer look and discover the real story on UK equities.
M&A activity in UK small caps has surged as private equity and overseas buyers capitalise on low valuations. This validates the view that UK small caps represent compelling value but also raises concerns.
Many businesses are being acquired before they can realise their full potential, offering short-term gains but limiting long-term value creation. That’s why we take an active approach to engagement, working with boards to ensure shareholders receive fair value.
Encouragingly, many companies are pushing back. A record number of share buybacks highlight management confidence in their prospects, suggesting that UK small caps are not just cheap – they are resilient.
While M&A activity has reduced the number of UK-listed small caps, limited new IPOs has been noticeable. However, there are some signs that the situation could improve, with several companies in the pipeline for the year ahead.
As valuations improve and investor sentiment shifts, we could see an uptick in IPO activity, providing fresh opportunities for investors. While it may not be a rapid surge, the gradual re-emergence of IPOs will be key to sustaining the vibrancy of the UK small-cap market.
UK small caps remain deeply undervalued, but conditions may be shifting. Potential rate cuts, structural growth themes, and rising M&A all point to an inflection point. While corporate buyers continue to take advantage of low valuations, the long-term opportunity lies in backing quality businesses with strong fundamentals.
With sentiment improving and IPO activity potentially set to return, UK small caps could be well positioned for a long-overdue reappraisal.
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