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Contrarian Small-Cap Investing
Bradley Radin, CFA1
Executive Vice President, Portfolio Manager/Research Analyst
Templeton Global Equity Group Templeton Investment Management
Small-capitalization stocks, or small-cap stocks, are those companies whose market cap is typically less than US$2 billion. Generally, small-cap stocks fare worse than large-cap stocks in a market downturn, but they typically also provide greater upside when circumstances improve. Essentially, the Templeton value approach to small-cap stocks is the same as our approach to larger stocks: we strive to buy shares at the lowest possible price in relation to what we estimate a company is worth over a five-year time horizon. Our focus is always on longer-term drivers of value rather than short-term trends and market sentiment.
Sir John Templeton advised that the point of maximum pessimism is the best time to buy stocks, so last year we took advantage of bottoming small-cap markets to buy what we considered to be decent stocks at spectacular prices. As we often do, we played offense by taking advantage of market dynamics that lead most investors to head for the hills. When markets rebounded some time later, Templeton's small-cap strategies benefited overall from this longer-term focus.
As far as sectors that were attractive to us, we saw that the consensus had been very negative regarding the consumer sector, which provided us with the opportunity to purchase stocks in the sector at very compelling prices. There are also some interesting industrials that have not yet risen that we believe could potentially benefit as the global economic recovery builds steam.
However, we do not make active sector decisions; we simply want to find decent companies selling at super-cheap prices. The profile we typically look for is a reasonably good company going through a bad patch-a firm that is experiencing short-term problems that can send the stock price down 60% to 70% from its peak, so that the company's long-term intrinsic value is not reflected in its current share price in our assessment. On average, we hold stocks for approximately four to five years, and when we buy into a name, our goal is for it to double over that period.
Regionally, Asia has been a good source of solid companies with good growth prospects and balance sheets selling at cheap prices. The balance sheets of many European companies tend to be far worse. We have been giving more attention to the U.S., as this region has increased in value a fair bit over the last two years. Many of these markets are no longer seen as "cheap," but the earnings we look at are not for the current year or even next year-they are earnings five years down the road. Although a lot of the broad market statistics are starting to look fair, or a bit more than fairly priced, we believe there is still room to find good ideas at cheap prices among individual stocks.
MSCI World Index vs. S&P Global <$2Billion Index
Monthly Returns in U.S. Dollars
One-Year Period Ended 30 November 2009
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Please click here for more information on the FTIF - Templeton Global Smaller Companies Fund.
Footnote
1. CFA ® and Chartered Financial Analyst® are registered trademarks owned by the CFA Institute.
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