Could weak sterling help this small cap to beat the FTSE 100?

Does this smaller company offer more growth potential than the FTSE 100 (INDEXFTSE:UKX)?

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Since the EU referendum, the pound has weakened significantly. Much of this has been caused by uncertainty surrounding the UK’s economic future. Therefore, the FTSE 100 has risen by around 18% since the referendum. Many of its constituents have operations outside of the UK and have therefore benefitted from a positive currency translation. However, the benefits of a weaker pound have not been limited to larger stocks.

A strong performance?

Reporting on Friday was recruitment company Harvey Nash (LSE: HVN). Its gross profit increased by 8% with the effects of a weaker pound factored-in. However, its underlying performance was less impressive. Its gross profit was 1% lower than in 2015, although this was in line with market expectations. Growth was held back in the UK and Ireland by Brexit uncertainty, while challenging market conditions in Hong Kong and higher costs in Vietnam meant its performance was somewhat downbeat for the year.

However, its gross profit increased by 4% in Mainland Europe on a constant currency basis. This shows that its strategy is working well overall, while a lack of debt and a strong cash position mean the company has the potential to deliver strong growth in the long run. And since sterling is likely to remain weak as Brexit negotiations begin, the company’s outlook may be relatively positive.

Growth potential

In the current year, Harvey Nash is expected to record a rise in its bottom line of 4%, followed by further growth of 9% next year. This puts its shares on a price-to-earnings growth (PEG) ratio of just 0.7, which indicates that there is significant upside potential. Certainly, there is scope for more disappointment in the UK, where the recruitment industry may face difficult trading conditions as Brexit uncertainty builds. However, this may be offset to some extent by weaker sterling, as well as upbeat performance from Mainland Europe.

Sector potential

Of course, Harvey Nash is a relatively small business and so may come with higher risk than a larger recruitment company such as Hays (LSE: HAS). Both stocks could benefit from weaker sterling and their strategies appear to be sound. However, since Hays appears to have stronger finances and a more diverse business model, it is likely to have a lower risk profile than its sector peer.

Furthermore, Hays is expected to record growth in its bottom line of 9% this year and 6% next year, which is slightly higher than that of Harvey Nash. However, since the smaller of the two companies has a PEG ratio of 0.7 versus 1.8 for Hays, it could deliver higher rewards.

Therefore, less risk-averse investors may prefer to take a close look at Harvey Nash over Hays, since it seems to have higher capital gain potential. Its shares may be volatile and it may lack the financial strength and diversity of large-cap peers, but its shares seem to be fairly priced at the present time.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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