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Why I’m investing in UK small-cap shares like this one

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My reading of the markets leads me to believe that ‘normal’ service has returned for UK small-cap shares. So, I’m not looking for so-called reopening stocks.

I’m not searching for over-priced growth stocks with high price momentum. And I’m not sifting through lists of deep-value stocks crushed by the pandemic.

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My focus is on shares with decent businesses and opportunities to grow their operations in the years ahead. And I want those companies to have sound finances and attractive valuations.

Holding for potential growth

When I find them, I’m keen to buy the stocks and add them to my diversified portfolio with the aim of holding them for a period of months or years. That will give the markets time to reappraise and rerate the shares to account for the value building in the underlying business.

However, nothing is guaranteed when it comes to UK small-cap shares. I could be wrong in my analysis of the underlying businesses. And unexpected news may surface to pull the rug from under the stocks I’m holding. Nevertheless, I’d embrace the risks in the pursuit of higher returns.

Right now, for example, I’m keen on groundworks and “geotechnical solutions specialist” contractor Keller  (LSE: KLR). In an update on 19 May, the company issued a positive outlook for the business. There’s a second-half bias to trading, but the directors expect to meet expectations for the full year in 2021.

City analysts predict earnings will decline by just over 30%, because of the pandemic, with a strong rebound in 2022. Meanwhile, the business has a strong multi-year record of rising cash flow and shareholder dividends. And with the share price near 805p, I reckon the forward-looking earnings multiple for 2022 is undemanding at just above nine.

However, groundworks contracting is a cyclical sector. And earnings have been volatile in the past. If a general economic downturn arrives, I could lose money with the shares. Nevertheless, I’d embrace the risk and add this UK small-cap share to my diversified portfolio.

Diversifying across UK small-cap shares

But Keller’s market capitalisation near £582m means the company deserves its place in the FTSE Small Cap index. And investing in small-caps can bring enhanced opportunities for investors as well as increased risks. It’s an age-old dilemma for me. Should I go for smaller companies in the pursuit of higher returns, or stick with big-cap shares because they tend to be more stable with well-established underlying businesses?

One way I’m aiming to answer that question and capture upside is by investing in small-cap funds that invest in a diverse array of related businesses. So far, the strategy’s working well. And it’s worthwhile because the FTSE Small Cap index has been a vibrant benchmark that’s often difficult to beat with stock picking. So, if I choose a fund that aims to follow it, I could be onto a decent long-term investment. However, past performance is no guarantee for the future.

For me, the solution to the investing conundrum is to target growth from UK small-cap investments using the shares of individual companies, trackers and managed funds.

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Kevin Godbold has no position in any share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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