The inexorable trend of investment towards indexation , which represents more than 50% of the flows of funds entering the market today, the increase in automated processes in investment decision-making and regulation, which in Europe took shape through Mifid II , it is leaving small and mid-cap companies off the radar , in which the number of analysts has been drastically reduced in recent years .
Four experts have debated these issues and the future of stock market analysis at the VIII IEAF-FEF Financial Monitoring Panel. held this Wednesday in Madrid.
With the numbers on the table, 70% of small and medium enterprises (SMEs) of up to 50 million do not have coverage and only 20% have coverage from a single analyst. The lack of coverage improves for SMEs with a capitalization of between 50 and 100 million, where the lack of coverage reaches 40%. The data is offered by Diego Ballón, senior associate at the firm Clifford Chance, to which Alfredo Echevarría, director of IEAF-Lighthouse, adds in his presentation: “In Spain, if there were no Lighthouse, the orphan rate would be 40%. something that also happens in other countries “.
The lack of coverage improves for SMEs with a capitalization of between 50 and 100 million, where the lack of coverage reaches 40%
“The conclusion after Mifid II is that it has been possible to carry out the transaction and eliminate the conflict of interest, but the stock market analysis has been reduced for medium and small companies,” explains Bayón. However, Mikel Tapia, Professor of Finance at UC3M Business, contributes from an academic point of view that the number of analysts has been decreasing since 2014, so it is not only the effect of Mifid II. “What matters is that in the European case, this drop is greater”, referring to the studies published by researchers Guo and Mota in 2021.
Alfredo Echevarría also disagrees on this point, who believes that Mifid is not the cause, but has catalyzed two processes. “It is a regulation that has stressed the banks’ model in terms of the profitability they offer for their analyzing business. Mifid has raised the alarm that it is profitable and a second question about the quality of the analysis and the perceived value of the Regulatory changes do not have the ability to improve the situation, “he explains.
Opportunity for active management
Lola Solana, manager of small caps and ESG at Santander AM highlights that, according to data from Goldman Sachs, passive management in the US represents 53% of management compared to 47% of active management, and it is precisely through active management where managers can differentiate themselves in this context of loss of analysts.
“Creating value in a company with more than ten analysts is difficult, but 47.6% of small companies are not covered by any analyst. The difference is brutal, and what is relevant is in those companies that are not being covered”, Solana explains. “Small companies are not on the indices. This offers an opportunity for active managers to find value, generate alpha and democratize investment. This is one of Lighthouse’s successes,” he adds.
Solana: “Small companies are not on the indices. This offers an opportunity for active managers to find value and generate alpha.”
Solana argues that, above value , growth or quality , there is an investment style that has done better when it comes to falling and rising: small caps . “They are so varied and the universe is so large that you will always find companies that regardless of how the economy goes, they will do well,” he adds.
However, analyzing the situation by country, the effect of passive management has been pernicious for some small caps, and specifically, for peripheral Europeans. While the American Russell since 2007 has appreciated around 250%, the British by 200% and on the continent the French and German, the Spanish, Portuguese and Italian have lagged behind.
“The Spanish companies barely weigh 3% in the indices, the flows have been much less”, details Solana, recalling that in some cases these companies had disastrous balance sheets but others have been treated unfairly. “There are interesting and solid companies that lag behind due to valuation and private equity so eager to grow, in recent years it has overshadowed Spanish companies.”
In Spain in 2007 the capitalization over GDP was 129%, in 2014 it rebounded to 134% and in 2021 it has fallen to 87%
Precisely, the Spanish market is narrowing because the number of takeover bids is higher than the number of IPOs, and as a consequence, the ratio of market capitalization to GDP is falling. “In Spain in 2007 the capitalization over GDP was 129%, in 2014 it rebounded to 134% and in 2021 it has fallen to 87%”, the manager details, lamenting that the Spanish market is getting smaller and smaller, it has fewer analysts and there is less investment interest in our country.
Quality versus quantity
Another controversy on which the participants have debated has been whether the fall in the number of analysts and the number of reports is having consequences on the quality of the analysis.
In Mikel Tapia’s opinion, “although there are fewer analysts, the forecasts they make are better. We expel the bad guys and stay with the good ones, that is, the analysts improve with their work.”
This is not the opinion of Alfredo Echevarría, who thinks that the economic value of analysis is now lower and if it is paid less it will lead to a worse quality. “At Lighthouse we do not give a recommendation or a target price because we think it is useless. Analyzing a company is an artisanal process where the analyst has to know the business, talk to management , make a model, refine the accounting, and this entire process has some costs, but well planned and managed is useful. “
For Lola Solana it is a reality that the number of analysts has fallen and “evident if the number of analysts falls and the number of companies to analyze is greater, the time that the analyst dedicates to each company is less and cannot deepen the same if it takes 7 companies that have 25 “, he says. “In that case the analyst tends to do a more basic analysis and what I am looking for is to go further, to analyze the projects, the pipeline one by one, to make a difference,” he says.