When it comes to investing in smaller companies, there is inevitably a higher risk of loss than among their larger peers. That’s not because they pursue the wrong strategies, lack management expertise or have products or services that are inferior. It is simply because history has shown that smaller companies typically come with additional risks, such as liquidity risk and spread risk (in terms of the difference between the bid and offer prices), as well as a narrower breadth of customers and products/services offered.
However, they can also offer greater potential rewards, too. They tend to be more adaptable to change within a marketplace than their slower-moving, larger peers and can also more easily take advantage of changing customer tastes, too. As such, smaller companies can prove to be excellent investments and, as history shows, they can outperform larger companies over a sustained period.
One stock that has most certainly beaten the wider index is recruitment company, Staffline (LSE: STAF). Its shares have soared by 1327% in the last five years as its bottom line has increased from 11.5p per share in 2010 to 60p per share last year. That’s a stunning rate of growth and, looking ahead, it looks set to continue as Staffline’s profit before tax is forecast to reach £35m (from £10m last year) in 2016.
And, despite its excellent share price performance, the company’s shares still trade at a very appealing price level, with them having a price to earnings growth (PEG) ratio of 0.6. This indicates that they offer growth at a very reasonable price and, with the UK economy going from strength to strength, Staffline appears to be a stunning buy right now.
Meanwhile, Majestic Wine (LSE: MJW) continues to struggle even though trading conditions are better than in previous years. In fact, it is expected to post another year of falling profitability, with its earnings set to decline by 5% this year following last year’s 11% fall. And, while a new strategy of revamping stores and even potentially lowering the six-bottle minimum purchase may produce improved results, investors are not particularly enthused – as evidenced by Majestic’s 1% share price rise in the last year.
However, next year could be a different story, with Majestic expected to post earnings growth of 22%. And, with its shares having performed poorly in recent months, the company trades on a PEG ratio of just 0.8, which indicates that after a difficult period things could be set to turn around for the wine retailer.
Of course, the oil sector has been a major disappointment in recent months, with a declining price hurting investor sentiment and pushing valuations southward. As such, it is of little surprise that shares in Rockhopper Exploration (LSE: RKH) have fallen by 31% in the last year. And, while Rockhopper’s valuation may come under further pressure in the short run if the oil price moves lower, its long term future appears to be relatively bright.
That’s because Rockhopper has a wide margin of safety that appears to price in further weakness in investor sentiment, as evidenced by a price to book (P/B) ratio of just 1.1. And, with it having a part-share in projects in the Falklands and the Mediterranean, it appears to offer a degree of diversification alongside a relatively well-funded drilling programme. Therefore, it appears to be a potentially highly rewarding stock to own for the long haul.
