The Great Disappearing Act:
Small and mid-cap stocks in sell side analysis
On the 19th October 2023, Perpetua Investment Managers Deputy Chief Investment Officer, Lonwabo Maqubela, participated and presented at the Investor Relations Society Of South Africa’s Annual Conference, hosted at the Johannesburg Stock Exchange “JSE”. One of the topics that was of interest was the decline of sell side research, impacting particularly small and mid-caps. This is best evidenced by the chart below.
Of the 150 odd counters that make up the All-ShareIndex, nearly half (68) have less than two analysts that make up the Bloomberg consensus. In fact, drilling down further into this data reveals that more than a quarter have no analysts that make up the Bloomberg consensus. Part of the problem is that these counters are small and collectively they makeup just over 10% of the All-Share index.
Whilst the data may be distorted by whether all the brokerage houses submit their recommendations, it is our view that it reflects the on-the-ground reality that a significant number of JSE listed counters are under-researched and are not well understood by the market. Part of the reason for the reduction in research services was due to European regulatory changes. Because many of the sell side houses are global players and could no longer provide the research in Europe, the regulatory changes impacted the profitability of providing research to the South African industry.
What further complicates this issue in the SouthAfrican context is that 27 counters make up nearly 75% of the index, the implication being that the sell side and many fund managers focus their attention on the all-important 75% at the expense of the many but under-researched shares.
At Perpetua, we believe that this has resulted in miss pricing in the under-researched segment of the market. We spend a significant amount of time on this segment of the market and periodically partner with boutique research houses to improve our understanding of these companies. Our clients have meaningful exposure to this segment of the market.However, because of the nature of the universe, we are very selective; focusing on companies with growth prospects, good cash generation, strong balance sheets and excellent shareholder aligned management.
In our discussions with portfolio companies, we encourage them to realize that this may be the new normal due to structural market changes (including the Regulation 28 changes implemented last year). We urge them to understand that instead of anticipating higher valuation multiples (re-rating) it is up to the underlying companies to improve shareholder returns through a focus on capital allocation, increased dividend payouts and share buybacks. We have also noticed that trade buyers are also taking advantage of mispricing and we have had several “take-private” realizations in client portfolios.
The conference was concluded by the JSE’s Chairman, Phuthuma Nhleko. One of his concluding remarks was that the South African bourse needs a wider range of capital providers (including greater retail participation) as this would result in a more sustainable marketplace. We agree with this assessment, and it is our view that an asset management industry that consists of more mid-tier scaled asset managers would improve the market’s price discovery.
“Of the 150 odd counters that make up the All-Share Index, nearly half (68) have less than two analysts that make up the Bloomberg consensus. In fact, drilling down further into this data reveals that more than a quarter have no analysts that make up the Bloomberg consensus. Part of the problem is that these counters are small and collectively they make up just over 10% of the All-Share index. ”