Buy, hold, sell: Three small-caps to own or ditch

This smaller companies trust has thrashed the market over the past year. Tom Bailey tells us which shares fund manager Georgina Brittain has been trading recently.

Smaller companies are 'the most exciting part of the stockmarket,' says Georgina Brittain, co-manager of JPMorgan Smaller Companies. Brittain describes the trust's stock-picking approach as being composed of three factors: value, quality and momentum.

Valuation is based on the usual metrics of price/earnings (PE) ratios and cashflow generation. For quality, which Brittain says is especially important in the smaller companies space, the trust looks primarily at return on investment or 'bang for buck'. Most emphasis, however, is on momentum. "Are earnings beatings expectations?" Is a key question, says Brittain.

This strategy appears to have worked well. In the past year to early September, the trust has seen particularly strong performance, returning 27.3% in share price terms compared to the sector average of 13%, according to Trustnet. Over five years it has gained 87.2%, against the sector average of 90%. Its three-year alpha score (calculated by looking at benchmark outperformance) is a strong 4.85%.

Past performance is not a guide to future performance

Buy

Keywords Studios (KWS: LON)

"Keywords Studios is basically a service provider for the video games industry," says Brittain. It provides technical services to the video games industry such as audio, adaption for different regions and translation, among other back-office tasks. "It's the "picks and shovels" behind the glamour of games, a market worth about $140 billion globally, she explains.

Within this market, Keywords Studios stands out. Many of its competitors provide just one part of the many back-office functions outsourced by video game creators. Keywords Studios, by contrast, is a consolidator, providing a wide range of services to video game companies. Listed on the Alternative Investment Market, the company's customers include Nintendo, Tencent and Electronic Arts.

Keywords Studios was purchased at £8.20 in May 2017. Its price at the end of August 2018 was around £20 per share. 

Past performance is not a guide to future performance

Hold

Alpha Financial Markets Consulting (ASM: LON)

"Very simply, this company is a consultancy focused on asset managers," says Brittain. Being an asset manager, she knows well the industry the company serves, and therefore understands the great drivers of growth that have propelled the company forward and should continue to do so.

Principally the industry is seeing regulatory changes, which consultants such as Alpha Financial Markets Consulting can help with. At the same time, a drive to cut active management fees is also creating cost pressures, leading to asset managers seeking advice on how to keep costs down.

Consulting is a people business, making Alpha Financial's good management vital, says Brittain. Research looking at employer review websites such as Glassdoor shows staff and former staff rate the management of the company highly, while staff retention is high. Additionally, JMI checks on the quality of service the firm provides by speaking to its users – other asset managers. Again, feedback has been positive.

The company fundamentals are strong. The firm, she notes, is highly cash-generative. Its operating income is currently around 20%. The company is also growing fast and has the sort of earnings momentum the trust looks for.

So why is the company a hold and not a buy? "Its current valuation puts it in the hold camp," says Brittain. While not doubting the firm’s future growth prospects, she notes that it is relatively richly valued on a PE ratio of 21.

JMI bought this stock when it floated in October 2017, for 160p per share. The price now stands at 265p. 

Sell

Topps Tiles (TPT: LON) 

As the name suggests, Topps Tiles is a tiling retailer. Brittain stresses that the company is well-run and has a large market share. However, she says, "when it comes to retail, it is the consumer who decides". If consumers are not willing to spend, even the best-run business will struggle. "As a retailer Topps is totally dependent on consumers," she adds.

This was the logic behind the sale of the company's shares in May 2017, part of a wider move out of retail for the trust. "We became concerned about consumer confidence and about the impact of currency movements on retailers. Both concerns have proved to be valid." JMI is now underweight retailers.

"While Topps Tiles is a very good company and has a dominant market share, as is the case for any retailer, it's about the consumer."

JMI sold Topps Tiles in May 2017 for 85p per share. As of the end of August, shares were trading at around 65p per share. 

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.