2021 outlook: Where to find hidden gems in the mid/small caps space

The small cap market has undergone significant fluctuations, mirroring the shifts in the global economy. In the wake of the Covid-19 pandemic, small cap stocks experienced a substantial sell-off early last year. However, towards the latter part of the year, there was a resurgence in demand for these stocks, indicating a potential turning point. Kerry Fynn, CEO at Alpha Asset Management, and Anthony Clark, Independent Analyst at Small Talk Daily Research, joined CNBC Africa to discuss the performance of the small to mid cap space in South Africa. Fynn and Clark shed light on the factors propelling the sector and highlighted some of the companies leading the gains. The year 2020 began on a positive note for the market but was soon disrupted by the unforeseen challenges posed by the pandemic. As Covid-19 swept through the globe, markets tumbled, with South Africa's small cap index plummeting by over 40% in March and April. Throughout the winter, the market remained volatile. However, by August 2020, signs of recovery started to emerge, particularly in the small cap and mid cap sectors. Despite the tumultuous year, the small cap index closed down approximately 3%, while the mid cap index fared slightly worse, ending down about 17%. In contrast, the start of 2021 has shown promise, with the mid cap sector outperforming the small cap index. Year-to-date, the mid cap index has surged by 10.5%, overshadowing the 5.6% increase in the small cap index. This shift indicates a broadening interest from institutions towards the mid cap market, which was previously dominated by retail investors and value funds. Fynn emphasized that many companies in the small to mid cap space have strong ties to the South African economy, which is poised for recovery after a challenging period. The anticipation of a global economic rebound has reignited foreign interest in emerging markets and commodity-producing regions like South Africa. Foreign net inflows into the domestic equity market have surged, signaling renewed confidence in the sector. Fynn highlighted the attractive valuation of several companies in the small to mid cap space, with earnings multiples as low as three to six times. These undervalued assets, combined with expectations of a South African recovery, present compelling investment opportunities. Clark delved into specific stock picks that have been driving the gains in the mid cap space. He emphasized the importance of conducting thorough research, especially in lesser-covered companies, to identify hidden gems. Clark noted that companies with positive trading updates have outperformed market expectations, drawing investor interest. He cited examples like Cashbuild, Bell Equipment, Cartrack, and AECI, which have delivered exceptional performances, driving the momentum in the mid cap sector. Clark reiterated the significance of finding undervalued companies that can deliver positive surprises, leading to significant share price movements. The conversation also touched upon the recent trend of mergers and acquisitions (M&A) in the market, with the acquisition of Adapt IT by Huge Group serving as a prominent example. While the deal signifies consolidation in the space, the success of such transactions hinges on the pricing and strategic alignment between the entities involved. The analysts expressed cautious optimism about the deal, noting that convincing Adapt IT shareholders will be crucial for its approval. As the discussion wrapped up, both Fynn and Clark shared insights on stocks to avoid or reduce exposure to in the current environment. Clark highlighted the challenges faced by primary food companies due to rising commodity costs, making them less attractive investment options. On the other hand, Fynn expressed reservations about certain high-priced stocks like Discovery and Capitec, urging investors to consider value opportunities in the lower end of the market. Overall, the outlook for the small to mid cap market appears positive, with a focus on uncovering undervalued companies with growth potential amidst the evolving economic landscape.