This is how novice investors could save UK stocks

Terry Tanaka asserts that private investors, not brokers and fund managers, should reap the rewards of a stock market recovery

Many businesses in the UK market will be looking to profit from the turbulence and uncertainty brought on by Donald Trump's trade policies. Investors are shifting their focus from the US to other markets, such as Europe and the UK, according to fund manager Jupiter. The biggest stocks will initially profit from this trend, according to stockbroker Cavendish, before smaller stocks follow. It is imperative that funds return to Britain, especially to small businesses, as soon as possible.

The start of 2025 has been poor once more, following three years in a row of monthly outflows. In the first three months of this year, UK-focused equity funds experienced their worst quarter. For the fourth consecutive year, there have been fewer companies listed on Aimjust 685 now, down from 1,700 prior to the financial crisis. Even the initial public offering (IPO) financing amount of less than 600 million last year understates the issues facing London.

Even though initial public offerings (IPOs) make news, listed companies that look to raise additional funds are also in a terrible state. The ability of management to request additional funding from equity investors to expand their company is one advantage of being listed on public markets. Invinity, a producer of vanadium-flow batteries, and Cohort, a defense organization that raised funds last year to acquire a company abroad, are two examples. Active fund managers, like Jupiter, have witnessed nearly 30 billion retail investor withdrawals since the pandemic began, but they are now less inclined than they were to support management of UK-listed companies looking for growth capital to expand.

Stockbrokers with structural weakness.

Independent stockbrokers that depend on their connections with qualified fund managers to make investments in new issues and placements, like Cavendish (LSE: CAV), Peel Hunt (LSE: PEEL), and unlisted Panmure Liberum, have been impacted by all of this. Their business strategy is under threat due to the London market's slump and the emergence of low-cost passive funds. For instance, after going public in 2021, Peel Hunt's revenue more than halved and its profits vanished. For the selling shareholders, the IPO was a great success (228p), but for those who purchased shares, which are currently trading at 85p, it was less successful.

Naturally, this also applies to other flotations from the pandemic era. 87 businesses raised £3.7 billion when they went public on Aim in 2021. Sixty-seven of those new issues have delisted or are now down more than 60%. In 2021, fewer than ten of them are trading above their float price. There is another aspect of the issue there. One could conclude that UK stockbrokers would clearly benefit from a recovery. Due to the numerous IPO failures, investors are cautious. The money may therefore move into inexpensive passive funds even if we witness a recovery in the UK markets. In that scenario, it is unlikely that stockbrokers selling overpriced floats or active fund managers will profit.

For UK stockbrokers, passive investing presents a structural challenge, despite the brokers' apparent poor management. Why a company the size of Cavendish, which reported a pre-tax loss of nearly £4 million for the year ending March 2024, needs two chief executives may be questioned by experts. If there is a requirement for duplication of management responsibilities at the top, it seems that the advantages of consolidation and cost reduction brought about by the merger of Cenkos and Finncap (which created Cavendish in 2023) have not reached the higher levels of the establishment.

Catching the wave.

The move away from large-cap US stocks can be advantageous in other ways. The Vanguard Global Small-Cap Index Fund is one example of a passive fund that focuses on smaller businesses and is well-diversified across nearly 4,000 stocks. By doing this, one can avoid exposure to the largest tech stocks, which have seen incredible returns over the past ten years but now face uncertain prospects. Nonetheless, the US markets have grown so powerful that even a small-cap tracker fund is 60% weighted in them. An FTSE All-Share or Developed Europe passive tracker fund might be a better option for taking advantage of globalization's reversal.

Because UK-listed global companies frequently trade at a discount to their US-listed competitors in the same sector, investors who would rather purchase individual shares rather than a passive index tracker might start by looking at these companies. For instance, despite not being a traditional value stock, Unilever (LSE: ULVR) trades at a price/earnings (p/e) ratio discount of about 30% to its US peer Procter & Gamble, with earnings 18 times that of the previous year. In the tobacco industry, New York-listed Philip Morris International trades on a p/e of 21, while BATS (LSE: BATS) trades on a p/e of less than 10. When comparing ExxonMobil and Shell (LSE: SHEL) or banks, JP Morgan and Barclays (LSE: BARC), we observe a comparable discount in the oil industry. Listed in the United States does not appear to justify such a high valuation premium for multinational corporations.

But this highlights another aspect of the UK market's issues. Regulators have long attempted to discourage people from making direct share investments. A lot of regulations make the implicit assumption that professionals who have access to company management and Bloomberg terminals are better than amateur investors. However, opportunities are frequently seized first by amateurs who are not restricted by liquidity or fund outflows. Eighty percent of Aim companies are worth less than £200 million, and most fund managers won't invest below that amount. However, according to Richard Penny, who manages the TM Oberon UK Smaller Companies Fund, the average size of the 23 UK-listed stocks that have seen a 100-fold increase in value since 2000 was less than 15 million.

Consider Games Workshop (LSE: GAW), which had a vocal following of retail investors long before the majority of professional fund managers took notice. Tom Kirby, the previous chair, had a very readable and entertainingly direct communication style, which is what drew me to the company. When the group reported an 11p loss per share in 2007 and was in debt, his "Chairman's preamble" claimed that the business had become "fat and lazy on the back of easy success." For professionals accustomed to language created by financial PR firms, this directness may be off-putting, but for amateurs, it is refreshing.

The diluted animal spirits caused by this regulatory bias are making it difficult for smaller businesses in the UK to raise growth capital in order to compete globally. The government appropriately encourages investment in startups by means of enterprise investment schemes (EIS) and venture capital trusts (VCTs). Despite their success, these VCT and EIS companies appear hesitant to list on UK markets (take fintech companies like ClearScore, Monzo, OakNorth, and Revolut as examples).

Encouraging individual investors to directly support IPOs is a clear solution to the declining size of active UK funds. But unlike previous duff IPOs like CAB, Funding Circle, and Metro Bank, this will only work if good listings are "priced to go" at attractive valuations. In the years following listing, amateurs will not put up with shares dropping sharply. They are not risking their clients' money, but their own.

The location of the upcoming Games Workshop.

There are several resources that make it simpler for novice investors who want to try their hand at investing in individual businesses. As long as investors self-certify as eligible, many small-cap brokers will make their research available online on their own portals or aggregated on Research Tree. Be mindful, though, that broker research frequently amounts to little more than a repetition of the investment case presented by management in their own investor relations materials, along with analyst projections based on management directives.

In fact, it is not unusual for management to advise their broker to reduce projected earnings while making ambiguously positive remarks in the outlook section of their regulatory news service (RNS) filings. Both the company's own website and the London Stock Exchange's website offer the RNS filings themselves. The lack of individual investors who read these announcements and determine whether or not management is being straightforward is startling.

For comprehensive information, check out ShareScope and Stockopedia. With a fraction of the price, these offer a large portion of the features of a professional Bloomberg terminal right on your desk. Several authors use the Substack platform to freely share their investment process and experience for truly independent research. Paul Scott, Small Caps Life, Terry Tanaka at Wonder Stocks, and Cockney Rebel (also known as Richard Crow) are a few examples. Former hedge fund analyst Stephen Clapham advertises his forensic accounting classes, which look for discrepancies in a company's financial statements. There is Tom Winnifrith, the self-declared "Sheriff of AIM," who takes a more combative approach.

Amateur investors have nearly the same access to Investor Meet Company live presentations as institutional investors. The difference is that viewers are unaware of which questions company management chooses to omit or avoid because they are unable to view the list of questions posed by other meeting attendees. Less than 1,000 interviews with UK companies and investors are available on PI World. Paul Hill, who invests his own funds at Vox Markets, also conducts management interviews.

None of these sources are perfect: Paul Hill lost a lot of money on his Argentex investment. The majority of authors will disclaim that their interviews and analysis are unregulated and do not constitute investment advice. Do Your Own Research, or DYOR, is a well-known acronym that has been used as a disclaimer. This "skin in the game" gives novice investors comfort rather than creating a conflict of interest. Would you rather pay attention to someone who invests their own money and loses money if they make a mistake, or to a regulated advisor who checks all the boxes and still gets paid even if their clients lose money?

The Mello conference and regular webinar are organized by renowned private investor David Stredder to bring like-minded investors together with businesses. These gatherings were first held at a restaurant called Mello, but now the conference takes up an entire hotel in Chiswick, west London. Investors can interact with other investors, many of whom have decades of experience and come from a variety of backgrounds, and meet company management and fund managers in person during the physical presentations. Most people view investing as a pastime and take pleasure in both the financial and emotional benefits. A Warhammer convention is comparable to the amateur investing community in that regard.