Searching for value

3 min read • December 5, 2022

Since October 13th, global stock markets have rallied 11%1 on lower-than-expected September U.S. inflation numbers and expectations that central banks will slow the speed of future interest rate increases. Despite the sharp market rally, one market segment that remains out of favour and inexpensive is the small-cap segment.

First, let’s define what a small-cap company is. There is no hard rule on what dollar value of market capitalization defines a small-cap company. We define small-cap companies to have a market capitalization of $100 million to $1.5 billion.

Second, the common investor perception is that small-cap companies are penny stocks or early-stage development companies. This is not true. All our portfolio holdings have a long-term financial track record, with strong balance sheets, and generate free cash flow to pay dividends, make acquisitions, or buy back shares.

Year-to-date small-cap stocks globally have underperformed large-cap companies. This market segment has been hit hard across the globe as fears of higher interest rates and a potential recession have dominated daily news headlines.

Typically, many small companies generate most of their revenues from the domestic economy and are less geographically diversified than large companies. As a result, investors have fled to the safety of larger capitalization companies, and small-cap stocks have underperformed their large-cap peers by a significant margin.

However, since the end of September, U.S. small-cap stocks have started to outperform their large-cap peers (see chart below). Institutional investors have started to rotate into small companies as most of the bad news about a pending recession has been well discounted in the market. Historically, small-cap companies outperform large companies coming out of recession since they have faster earnings growth.

So why should you own or buy more of the Matco Small Cap Fund today?

Here are six reasons:

  • Trading at a 50% valuation discount to the TSX Index2
  • It has a 4.8% dividend yield compared to 3.2% for the TSX Index2
  • Generates 30% of its revenue from outside Canada2
  • Our holdings continue to increase their dividends consistently
  • Investor sentiment towards small-cap companies is negative — thus, a contrarian indicator
  • Smaller companies have faster earnings growth potential resulting in higher capital appreciation over the long term

The Fund is well-diversified and owns companies such as:

  • Information technology-based land registries
  • Cybersecurity provider for governments and the education market
  • Packaging company serving the healthcare, cosmetics, and food/beverage segments
  • Digital media company serving small to medium businesses

The Bottom Line

Small-cap companies are a unique stock market segment that requires more due diligence and patience when investing. We believe that all investors should have exposure to small-cap companies. The percentage will depend on your overall asset allocation based on your specific investment horizon and return/risk profile.

The Matco Small Cap Fund provides higher return potential than the overall market with a valuation discount and a higher dividend yield for long-term investors.

Anil Tahiliani

Anil Tahiliani MBA, CFA

Senior Portfolio Manager

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1Source: Vanguard Total World Stock ETF (in Canadian dollars from October 13 to November 30, 2022), Bloomberg
2 Source: Morningstar, CPMS as at November 30, 2022

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