Small Cap Optimism – Same Results as the Big Guys

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Graham Copley / Nick Lipinski

203.901.1629/203.883.1927

gcopley@/nlipinski@ssrllc.com

March 31st, 2015

Small Cap Optimism – Same Results as the Big Guys

  • We apply our recently published work on corporate optimism to our recently expanded small-mid cap universe. The results are overwhelmingly consistent with the work on the broader Industrials & Materials universe.
  • Due to the short history of many of these small-mid cap companies, we look at optimism on a five year annual and three year quarterly basis. Our work on the large cap space considered a 10 year annual history – see prior research.
  • The optimists have a five year declining return on capital trend, decreasing at a rate of 5.3% per year, versus an upward sloping ROC trend for the conservative group, growing at 4.7% annually – Exhibit 1. This erosion in return on capital manifests itself in widespread underperformance on a number of measures – the right chart of Exhibit 1 represents average metrics over the past five years.
  • Looking at 2015 EPS estimates, the optimist group has already seen negative revisions double in magnitude compared to the conservative group. The optimists are still calling for 20% EPS growth in 2015 on average, compared to just 1% for the conservative group – see the full tabular results in Exhibit 6. The component stocks of the optimistic and conservative groups are shown in Exhibit 5.
  • We also run the analysis at the small (market cap under $3 billion) and mid ($3-10 billion) cap level, and find the overall results hold. Small cap results are shown in Exhibits 7-10 and mid cap results are shown in Exhibits 11-14.
  • Within the optimist group, JBT, NPO, KMT, and ASH are currently the valuation outliers on the expensive side. TRN, FSS, ARII, and OSK screen the cheapest within the conservative group.

Exhibit 1

Source: Capital IQ, SSR Analysis

Overview

Carrying on from our recent look at corporate optimism, we find further support for the conclusion of chronic underperformance and capital erosion for those companies with habitually optimistic outlooks at the small-mid cap level. The historical correlation of EPS revision and performance is not materially different for these smaller names (in fact it is a touch higher than we saw for our broader large cap group), and as we found previously, the results consistently hold for nearly every imaginable cut of the data and on virtually every relevant metric. Here we look at a 5 year annual history (versus a 10 year history for the longer data sets of our larger cap names) and a 3 year quarterly history (similar to the larger cap analysis). Exhibit 3 lists the companies that appear in the optimistic and conservative groups, ranked by the current percentage above the respective three year EV/EBITDA multiples – JBT, NPO, KMT, and ASH are the logical short picks among the optimists while TRN, FSS, ARII and OSK are the logical longs.

Exhibit 2

Source: Capital IQ, SSR Analysis

Exhibit 3

Source: Capital IQ, SSR Analysis

Quarterly

Exhibit 4 is the three year quarterly version of the right chart in Exhibit 1. The gaps between the optimist and conservative group are magnified here, and intuitively the quarterly cut should highlight companies that fail to detect and correct overly optimistic expectations early on in the year and therefore destroy the most value as results trail estimates throughout the year.

The composition of the optimist and conservative groups is summarized in Exhibit 5 and Exhibit 6 looks at current estimates and historical EPS for these names. Year to date the optimists have seen negative revisions nearly double that of their conservative counterparts. Consensus sees greater than 20% EPS growth for these optimists in 2015, versus just 1% for the conservative names.

Exhibit 4

Source: Capital IQ, SSR Analysis

Exhibit 5

Source: Capital IQ, SSR Analysis

Exhibit 6

Source: Capital IQ, SSR Analysis

Below we stratify at the small and mid-cap levels, showing the 5 year annual and 3 year quarterly analysis, the component stocks in each cut, and the return on capital trends for both groups.

Small Cap (Market Cap under $3 Billion)

5 year annual

Exhibit 7

Source: Capital IQ, SSR Analysis

3 year quarterly

Exhibit 8

Source: Capital IQ, SSR Analysis

Exhibit 9

Source: Capital IQ, SSR Analysis

Exhibit 10

Source: Capital IQ, SSR Analysis

Mid Cap (Market Cap $3-10 Billion)

5 year annual

Exhibit 11

Source: Capital IQ, SSR Analysis

3 year quarterly

Exhibit 12

Source: Capital IQ, SSR Analysis

Exhibit 13

Source: Capital IQ, SSR Analysis

Exhibit 14

Source: Capital IQ, SSR Analysis

©2015, SSR LLC, 1055 Washington Blvd, Stamford, CT 06901. All rights reserved. The information contained in this report has been obtained from sources believed to be reliable, and its accuracy and completeness is not guaranteed. No representation or warranty, express or implied, is made as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein.  The views and other information provided are subject to change without notice.  This report is issued without regard to the specific investment objectives, financial situation or particular needs of any specific recipient and is not construed as a solicitation or an offer to buy or sell any securities or related financial instruments. Past performance is not necessarily a guide to future results.

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