How to pick the best UK small companies to invest in

When it comes to investing in the stock market, we all know the UK is cheap. But smaller companies are even cheaper, and while they might be harder to research, they can pay off big.

Fraser Mackersie and Simon Moon, co-managers of the Unicorn UK Income Strategy, UK Smaller Companies and UK Growth funds are tasked with finding the best British companies to invest in outside the FTSE 100, but the selection of small companies has been rapidly reducing in recent years.

Only around 700 companies are left on the UK’s AIM market, the fewest since 2002 and less than half the number during the market’s heyday in 2007.

However, Mackersie and Moon were undeterred, with the former stating that while “if it persists, it will be a bit troubling,” but with over 700 companies to pick from, there was still plenty of choice.

“While many have made quite a bit of noise and splash as they’ve left, and complained about AIM and the liquidity, at the point at which they’d left, they’d not really been appropriate contenders for the fund,” he said.

“We want a thriving UK market, and we think AIM has got an important role in that,” said Moon.

“This is a cyclical dynamic, you see this when times are tough. Companies get taken out and there are very few IPOs to refill that hole. But, we’re hopeful, as conditions improve, that will start up again.”

“[Looking at the companies left], more of them are profitable, more of them are dividend paying, more of them are of a size that allows investment from a fund like this. So the general picture has improved, I’d say.”

The best UK businesses to invest in

Speaking to City A.M, the two managers gave a sense of the kinds of British businesses they’re looking to invest in, such as engineering company Goodwin.

The Stoke-on-Trent-based firm is the crown jewel of the managers’ portfolios, being their largest holding for at least the last 18 months and having first been bought a decade ago.

Since then, the value of Goodwin’s stock has doubled.

“It’s a great example of a real quality smallcap that has been off the radar for a long time, but has now moved onto the FTSE 250 fairly recently, so more and more people will be looking at it,” said Moon.

The managers described it as essentially a ‘family run business’, being run by the seventh generation of Goodwins over close to 200 years.

Goodwin has dozens of speciality businesses inside of it, making everything from radar for airports or pumps for dredging.

“The key thing is that they can make very specialist components and bits of machinery, for example, huge hole casting, at such a capacity and scale that when I first looked in 2014, only two other companies in the world could match,” added Moon.

“It really highlights why we love equity investing and why we love small and mid-caps,” added Mackersie. “Because you get to learn about all this type of stuff while meeting people who run great businesses with wonderful long-term prospects.”

Other highlights of Unicorn’s portfolios include Mercia Asset Management, which has been a strong beneficiary of the government’s levelling-up plans to invest across the UK.

The regional asset manager has seen its stock price shoot up 36.5 per cent this year as the British Business Bank has gifted it a range of contracts to invest in regions like the Midlands.

Recovery in the UK?

Construction is another major area for UK small caps, as British businesses gear up for the promise of a building boom under Chancellor Rachel Reeves.

Howdens, the UK’s largest kitchen manufacturer, Mashalls, the UK’s largest block paving manufacturer, and Stelrad, Europe’s largest radiator manufacturer all sit in the portfolio.

The managers were hopeful for a pickup in the UK economy and were very pleased that the Bank of England had begun to cut interest rates, but were cautiously watching news emerge on the budget.

“It feels like we’re being softened up for an ugly budget, which I don’t think will be as ugly as we’re being told,” said Moon.

“There’s an opportunity now for it to be quite positive,” added Mackersie. “The UK is in reasonably good shape, the fastest growing in all the developed nations this year.”

“We don’t want this budget to take the wind out of our sails as momentum is building. Who knows what policies they’ll put in, but we feel like things are a little bit better, and I just don’t want to step back.”