Zande: Multiply your moola with mid- and small-cap stocks

Zande, which means “multiply” in isiZulu, is a portfolio of mid- and small-cap stocks designed to give investors an opportunity to invest in fast-growing companies in this niche sector of the market.

What are mid- and small-cap stocks?

Companies are categorised by size – namely small, medium and large – based on their total market capitalisation or “market cap”. The market cap of a company is simply the value of that listed company, which you can work out by multiplying the current share price of the company by the number of shares.

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In the local market, the JSE Top40 is made-up of the largest 40 companies referred to as the Large Cap Index. The Mid Cap Index is made-up of stocks ranked 41 to 100 in market cap; and the Small Cap index is made up of companies with a market size from 101 to 160. Companies smaller than this are referred to as Fledgling, and below this are MicroCap stocks.

Why buy mid- and small-cap stocks?

If your primary goal is to “beat the market”, then one of the ways that you can do this is by investing away from the stocks that make up “the market index” (namely the JSE Top40). This makes the case for mid- and small-cap shares. And in the long-term, mid- and small-cap companies have enjoyed superior growth to large-cap companies, as the chart below shows. This part of the market is less accurately priced, creating more opportunities to find great businesses that are trading well below fair value.

Chart 1: FTSE/JSE Mid-Cap and Small-Cap Performance, 1995-2019

Are mid- and small-caps risky?

The most significant driver of a share’s price is its earnings and the earnings of mid- and small-cap companies are more volatile than larger, diversified companies. While the mid- and small-cap sectors tend to experience greater volatility than the broader market, as stated, these shares have historically outperformed larger companies over time due to the dual benefits of a re-rating of stock prices off lower purchase prices alongside higher earnings growth potential as the business scales.

Chart 2: History as a Guide

Source: Adrian Saville & Andrew Dittberner, Cannon Asset Managers (2016) JSE 1993-2013
LG: Large Growth Companies, LGARP: Large Growth Companies at a reasonable price, MG: Mid-Sized Growth Companies, MGARP: Mid-Sized Growth Companies at a reasonable price, SG: Small Growth Companies, SGARP: Small-Sized Growth Companies at a reasonable price, LV: Large Value Companies, , MV: Mid-Sized Value Companies, SV: Small Value Companies

Why the Zande bundle?

South Africa’s investment universe is comparatively small and yet, outside of large-cap stocks, relatively unknown. Given the concentration of stocks in the Top40 index, most asset managers overlook the 80% of the JSE that falls outside of this sector (namely the Mid Cap Index and the Small Cap Index, as well as stocks that fall into the Flegdling and MicroCap sectors). Over many years, we have developed a rich research knowledge and deep understanding of all sectors of the JSE. This gives us the ability to add unique elements to our clients’ portfolios.

Cannon Asset Managers’ Zande bundle holds such stocks as Santova, PSG Group and Datatec: well-respected and well-known companies with great growth prospects. Zandle also holds companies of lesser known names of the same calibre, and rightly so, as these hidden gems (Purple Group and Altron) often prove to offer the most valuable returns. Significantly, the Zande bundle offers investors a chance to invest in this sector of the market, with no investment minimums, and an effective annual cost (“all-in” fee) of just 1.28%.

Why now?

Despite the current tough environment, the companies that Cannon Asset Managers invests in are profitable dividend payers with healthy cash flows and decent returns on equity. Price-earnings multiples are undemanding at current levels, to the extent that all that is needed is a modest re-rating to the long-term average to make mid- and small-caps a great investment (without depending on significant increases in earnings).

Conclusion

While size and value are powerful ingredients in predicting excess returns, they require a third – and arguably more powerful – ingredient: time. For investors who take a longer-term view (those with at least a five-year time horizon), the small- and mid-cap stocks on the JSE offer an extremely attractive investment opportunity.

View Zande bundle
on EasyEquities