After a challenging year in 2022, German equities are increasingly back in investors' focus. However, investors often initially focus on the standard stocks. Alexander Dominicus, Portfolio Manager at MainFirst, assesses the performance of smaller German companies (MDax, SDax) compared to Dax groups this year.
“The second-tier stocks lag behind and only become interesting again once the rally has consolidated,” says Alexander Dominicus. In addition, there are still many sceptics in the market who do not fully trust the strong market performance and feel more comfortable with blue chip stocks in order to retain the flexibility to react to changes at short notice.
“We do not consider smaller companies to be fundamentally riskier,” adds Alexander Dominicus. “For us, the risk is in the company and the business model rather than in the share price movement.”
This requires fundamental analysis and how vulnerable the company's sales are, for example, in an economic downturn. The quality of the balance sheet also plays an important role in assessing risk. After all, there are cyclical companies with poor balance sheets in both blue chips and small caps.
When evaluating potential investments in smaller companies, the quality of the management team becomes important. “The smaller the company, the more important management is. While large companies are often dependent on the performance of their markets and industries, good management can make a much bigger difference in a small company. This is why it is so important to us when selecting stocks. We prefer the type of entrepreneur who identifies with the company and has invested his own money, rather than the employed manager in a large corporation.”
Mechanical engineering and IT
Mechanical engineering is one of the sectors MainFirst is looking at. “We look at where German companies excel, and which sectors offer the greatest long-term opportunities. Germany is certainly a country of engineers and has many hidden champions in industry, for example in mechanical engineering. These products are often world class and play a key role in the automation of production processes. The technology sector is also interesting in the long term. Here too, Germany has many second-tier companies, such as IT service providers, which are driving the digitalisation of the Mittelstand.”
MainFirst is on the lookout for companies that can grow organically, for example through structural growth, market share gains or efficiency improvements. “The valuation of the company and the quality of its management are also key factors in our analysis. We look for conservative and reliable managers. If the criteria are met, we invest for the long term, with a time horizon of three to five years.”
What are the long-term growth prospects for smaller German companies compared to large corporations? Alexander Dominicus: “While it is difficult for large companies to gain market share, small companies can usually grow on their own. In this context, the portfolio as a whole should offer significantly more growth potential than the economy as a whole. In the first quarter, for example, our portfolio companies achieved double-digit sales growth on a weighted average basis, while economic growth in Germany was actually slightly negative. It is important to have an investment horizon of at least three to five years, ideally longer. It is also important not to get nervous about price fluctuations, as we are convinced that in the long run prices will follow fundamentals and reflect the growth of the companies.”
