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RENEWED interest is stirring in small capitalisation equities – and for good reason, according to STANLIB, the country’s leading unit trust company. JSE equity gains in 2005 were underpinned by the powerhouse performance of resources which rocketed 71.5%. Market-watchers are now trying to identify the ‘out-performer’ of 2006, with small caps high on the list of potential big winners. Anthony Sher, manager of STANLIB’s Small Cap unit trust, says five key factors stoke interest in the sector: Parallels with 2004, the most recent ‘annus mirabilis’ for small caps. Renewed rand strength. Stronger balance sheets at many smaller companies. Expectations of a pick-up in mergers and acquisitions (M&A) and new listings. Focus on well managed technology companies, smaller financial service players and construction counters. Sher has good reason to remember the factors which drove 55% gains in the small cap index in 2004. His award-winning fund achieved 64% growth that year. He notes: “In 2004 some retail counters achieved exceptional gains. That year the rand strengthened considerably, which helped smaller companies focused on the domestic market. “Parallels with our current situation are obvious. We have recently seen renewed rand vigour while local retailers continue to benefit from consumer confidence and low interest rates.” Small cap interest is not simply a matter of déjà vu. Sher explains: “New factors in the mix include stronger balance sheets and a belief in some quarters that renewed corporate activity is imminent. “Many smaller operations are strongly cash generative. Domestic growth rates of 4-5% have contributed to robust health for many small and mid-cap companies. “As the managements of these companies prove their ability to add value and build profit, so they attract the attention of industry leaders – setting the scene for M&A activity. The strong economy and good cash-flows may also contribute to new listings on the Alt-x and perhaps the graduation by some successful Alt-x players to the JSE’s Big Board.” Corporate activity would tend to focus investor interest on small and mid-cap stocks at a time when many investors are looking for new directions. After nearly three years of broad-based equity growth, some fund managers are adopting a selective stock-picking strategy as a way of protecting gains without retreating from equities. This tactic could benefit smaller financial service players and technology companies which have bounced back from the IT slump of 1998-99. Says Sher: “Some financial service players have benefited greatly from the equity boom of the last 32 months. They are well managed and may offer value opportunities. “The same can be said for some technology counters. Companies which survived the late ‘90s shake-out did so because they are well run and have a solid client-base. These companies have had seven years to grow and warrant a new look.” Investors taking a thematic approach have also focused on the construction sector as infrastructure development is a strategic theme for policy-makers looking to create jobs and boost fixed investment. Again, some small and mid-cap construction counters are well placed to benefit. Sher notes: “Small cap companies do not generate huge trading volumes. Therefore, many stockbrokers do not believe they warrant big research coverage. This creates an opportunity for an in-house research company like STANLIB that can apply major resources to relatively under-researched companies. “We are seeing increasing demand for authoritative data on small caps with big potential. This is perhaps the strongest indicator of all that this sector is increasingly attractive for those looking for extra equity upside in the coming months.”