British small caps: an underappreciated industry rich in potential

Three UK small caps are highlighted by fund managers at the Henderson Smaller Companies investment trust as potential investments

The Henderson Smaller Companies investment trust, which focuses on British small-cap stocks, invests in UK-listed companies at their most promising stage of development in an effort to provide long-term capital and income growth. By capturing the small-cap premium through disciplined valuation, our stock-picking strategy aims to spot this growth before others do. We make sure to invest only in situations where prices do not yet accurately reflect a company's solid fundamentals in terms of growth and cash generation.

A turbulent decade for British small-cap stocks, which started with anxiety over the EU referendum and ended with an energy crisis and a sharp increase in interest rates, has left this segment of the market unloved, ignored, andmost importantlyrich. We highlight three British small-cap stocks with their own history, precedent transactions (the price at which peers have recently been acquired in merger and acquisition deals), and low prices when compared to their international counterparts.

Promising small-cap British stocks for your investment portfolio.

Oxford Biomedica (LSE: OXB) is a contract development and manufacturing organization (CDMO) that specializes in producing viral vectors for cell and gene therapy, which are used in an increasing number of novel applications and as treatments for rare genetic diseases and cancer. Only a small number of companies worldwide are able to develop these technologies on a commercial basis. With increased capacity coming online at its Oxford (UK) and Durham (US) facilities, the company has set ambitious targets to more than double revenues by 2028. The market is expanding at a rate of more than 20 percent annually. Despite faster anticipated sales and earnings growth, the shares trade at roughly a 30% discount to peers that are listed internationally. The CDMO industry has seen significant consolidation in recent years, and private equity firm EQT's interest has made the stock appear even better.

Rathbones (LSE: RAT), which offers financial planning and investment advice, is in a good position in a world where financial-services companies are vying for customers. Demand is being driven by aging populations and growing wealth and personal taxes. The shares have an alluring dividend yield and are trading at a sharp discount to multiples that NatWest recently paid for smaller rival Evelyn Partners.

Operating in a structurally expanding segment of an already sizable market, Everplay (LSE: EVPL) is an independent video game developer and publisher with a strong business model. Businesses invest a lot of money in individual titles in the premium "AA" and "AAA" segments of the market, and they need big hits to generate returns. The smaller, autonomous players are not the same. Everplay releases roughly ten new games annually and spends an average of £1 million to £1.5 million on each game, so risk is spread out and profits are not reliant on any one release. A solid back catalog of popular games that are still profitable accounts for about 75% of earnings. Worms, for instance, is still profitable even after more than 20 years.

Additionally, it owns StoryToys, a mobile "edutainment" division that targets younger players and generates recurring revenue, and Astragon, a simulation-gaming company with a niche clientele. The shares of Everplay, a leading scaled player in its industry, trade at just over seven times EV/Ebitda, a significant discount to peers, previous transactions, and its own history, despite the company's steady growth, robust pipeline for this year, strong cash generation, and substantial firepower to pursue mergers and acquisitions to drive incremental growth.