Philip Best, Argos Investment Managers

Investors can find value in European micro cap shares in 2014

There’s plenty of value to be found in European microcap shares for investors in 2014, according to veteran European small cap investors Philip Best (pictured) and Marc St John Webb at Geneva-based Argos Investment Managers. 

Despite an outstanding 2013 for the duo’s Argonaut fund, which has risen by 39.2% since 1 January, they believe that many European stocks in their universe remain significantly undervalued.

“While 2013 has been a good year for Argonaut, our numerous ‘boots on the ground’ trips into the heartlands of industrial Europe still reveal plenty of deeply undervalued quality small businesses whose prices have yet to get back to anywhere near their 2007 highs,” says Best

“And you have to remember 2011 and 2012 were pretty bad years for the European microcap sector so it’s of no surprise to us that, in valuation terms, there’s plenty more to go for in 2014,” says St John Webb.

Best and St John Webb have been on an extended ‘walkabout’ in Continental Europe for over 25 years and their expertise in fundamental “deep value” investing in European small quality companies has maintained Argonaut – with its ten year track record – in leading competitive positions in the top quartile of the European Small Cap sector in one, three, five and ten year periods. 

In their investor review of Argonaut’s 2013 performance the duo were keen to bury the idea that Argonaut’s performance was down to it being particularly volatile pointing out that over time the fund has had annualised volatility of around 16% - or about the same as the equity markets in general. They explained that their 2013 performance had not been achieved by investing in highly volatile “penny stocks” but in quality small European companies which simply went unnoticed because most were not followed by brokers.

The British duo go to some lengths to explain to investors that there are a number of key points which they have looked at and which should give some comfort to those considering investing in the European microcap sector in 2014:

  • The Russell 2000 Small Cap index in the US is now 30% higher than its pre-crisis high in 2007, whereas the MSCI European Small Caps index is still 6% below its 2007 high.
  • If you take each individual stock in the portfolio and calculate where it stands in relation to its level in 2007 the average stock in the portfolio is still 40% off its high.
  • There are only 5 stocks in the portfolio that are currently hitting all-time highs. 
  • The median price-to-book ratio on the fund currently stands at 1.1 times. In 2007 the MSCI European Small cap trailing price-to-book peaked at 2.8 times and currently stands at 1.7 times. 
  • Corporate M&A has picked up, but still stands at low levels. The average takeover premium that has been paid for stocks held in the fund has been in excess of 50%, suggesting that the “market value” of the companies is well below the “intrinsic value” to a real-world buyer. 
  • The team has been taking profits on a number of the fund’s stronger performers and have reallocated the proceeds to new investment opportunities with lower valuations. 
  • The ‘Grey Area’ universe of “value” microcaps is only just beginning to come to life after a substantial underperformance over the last 5 years, so the team are still finding many new investment opportunities in unloved orphan stocks at low valuations. 

In their annual Argonaut Fund review Best and St John Webb have provided a number of examples of their “deep value” strategy in action by offering examples of how individual stocks have performed. One example features the large scale Italian air conditioning equipment business Delclima -  a spin-off from Delonghi in which Argos invested at a 58% discount to book value. The duo bought a sizeable position in the stock, but doubled up on the investment after an onsite meeting at the company’s production site in the Veneto region of Northern Italy.  The investment has paid off because the stock is up 50% in the past two months.

Perhaps even more dramatic is the example of German semi-conductor and metal hardening business PVA Tepla which rose 41% following indications that sales in solar crystal growing business could pick up. The key point made by Best and St John Webb is that even after the rise, the share price remains some 78% below its pre-crisis highs.

Looking more broadly, Argos Investment Managers’ CEO Jean Keller, says: “The uptick in European equities is having a more dramatic impact at the smaller less -researched end of the stock market where there is a more level playing field between the large mainstream asset management businesses and specialist boutiques such as Argos. While the opportunities provided are a natural consequence of how markets operate, benefiting from those opportunities is down to the expertise specialists such as Philip and Marc have developed over years of focusing on such stocks".

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