Want to invest in the companies of the future? Look no further than the FTSE 250. This mid cap stock index comprises the 101st to 350th largest companies on the London Stock Exchange.
Mid caps are a sweet spot for innovation and disruption. Unlike many small cap companies, mid cap firms tend to have proven business models and more resilient balance sheets. And in contrast to most large cap giants, mid caps usually have a long growth runway ahead of them.
Generally speaking, mid caps are more agile than often limbering large caps. This allows them to scale rapidly, innovate and adapt to economic shifts.
Hats off to the 250
You may be surprised to learn that the FTSE 250 has beaten most developed market indices over the long term. That includes the tech-heavy S&P 500 in the US.
In part, this outperformance reflects the fact that UK mid caps are positioned in a sweet spot for innovation, disruption and growth. This is one of the key reasons why the FTSE 250 has produced a significant number of ‘30 baggers’ over the past three decades.
The Heineken Index
The FTSE 250 covers a hugely diverse set of companies doing business in the UK and overseas. In fact, around half the revenue that FTSE 250 companies generate comes from outside the UK. The mid cap index is constantly being refreshed through IPOs, M&A, promotions from the small cap index and demotions from the FTSE 100.
This is why the term ‘Heineken Index’ is playfully used as a nickname for the FTSE 250. This comes from the famous Heineken advertising slogan – ‘refreshes the parts other beers cannot reach’.
Mid caps generally receive less analyst coverage than large caps. This allows active fund managers to exploit pricing inefficiencies and unearth hidden gems before they are fully valued. Last but not least, mid caps make prime targets for larger corporations looking to buy growth. They are often on the receiving end of premium-priced takeover offers.
Why buy UK mid caps now?
Jean Roche, manager of Schroder UK Mid Cap Fund (LON:SCP), points out UK mid caps currently trade at multi-decade valuation lows. This is relative to their own history, UK large caps and most developed market peers. And it suggests there is scope for a re-rating.
Geopolitical developments and UK political uncertainty have weighed on short-term investor sentiment. Furthermore, the economic outlook for the UK remains uncertain.
Yet Roche argues: ‘The valuation case for UK mid caps is as compelling as we can recall. The FTSE 250 Index is trading on approximately 11 times forward earnings. That is well below its long-run average and a significant discount to the US, Europe and UK large caps.’
Roche also notes the undervaluation of UK mid caps is increasingly being recognised through corporate activity. ‘Trade buyers and private equity continue to pursue acquisitions at significant premia, seeing the same opportunity we do,’ she explains.
‘And UK companies themselves are buying back their own equity at record rates. The UK has become the buyback capital of the world, which is a clear signal that management teams believe their own shares are too cheap.’
An outstanding opportunity
Simon Murphy manages the VT Tyndall Unconstrained UK Income Fund (BYX0D61). He tells Sharesify that since the end of August 2021, the FTSE 100 has delivered a total return of 78% compared to the FTSE 250 (ex Investment trusts) return of 11%.
‘Historically, the FTSE 250 has strongly outperformed the FTSE 100 over long periods of time and so this sustained period of underperformance is both unusual and notable,’ notes Murphy.
‘As the FTSE 250 is typically more exposed to the UK domestic economy than the more international FTSE 100, explanations for the above include continuing Brexit uncertainty, ongoing political upheaval, relentless outflows from UK actively managed funds (that are typically more exposed to stocks outside the FTSE 100) and much more.’
Regardless of the exact reasons, Murphy sees this set-up presenting an ‘outstanding opportunity to see strong outperformance from the FTSE 250 in the years ahead’. A combination of cheap valuations and extremely depressed sentiment is what excites Murphy about the FTSE 250’s future return potential.
‘As always, we cannot determine exactly when sentiment will turn more positive,’ cautions Murphy. ‘But we are sure it will in due course. We also note the increased level of M&A activity taking place in the UK currently as a sign that private equity firms and overseas corporates see similar valuation opportunities as we do.’
Unicorn Asset Management’s Fraser Mackersie says the prolonged period of mid cap underperformance is ‘highly unusual in both its length and depth. This dynamic has created significant valuation opportunities in a number of high-quality FTSE 250 companies, where share price performance has become detached from operational performance, leading to a widespread de-rating.’
Managers’ mid cap favourites
Below, four professional money managers who invest in the FTSE 250 highlight some of their favourite UK mid cap stocks.
B&M European Value Retail (LON:BME)
Simon Murphy flags the attractions of B&M, one of Europe’s leading variety discount retailers with over 750 stores across the UK.
‘Having previously been a fantastic growth story, with the share price peaking at just under £5 at the end of 2023, the business has suffered several “growing pains” amid a major transition of leadership from the Arora brothers who had grown the franchise so successfully,’ says Murphy. ‘Consequently, the share price has fallen circa 60% to just under £2 today.’
With new management in place and stage one of the three stage Back to B&M Basics plan almost complete, Murphy says the early signs of improved operating and financial performance are encouraging. Product ranges have been rationalised and significant price discounts to the big supermarkets reestablished. Murphy also observes that product availability has improved, and space has been freed up to drive more promotional activity.
| Share price: 199.4p | Market cap: £1.94bn |
| FTSE Sector: Retailers | CEO: Tjeerd Jegen |
Source: London Stock Exchange
‘With stage two set to deliver updated store concepts, process simplification, increased use of customer analytics and automation, we are optimistic that the financial performance of B&M will improve materially from here,’ enthuses Murphy.
‘Currently trading on a P/E of circa 10 times, a dividend yield of circa 5% and a free cash flow yield of around 14%, the shares look extremely attractively valued today,’ he insists. Murphy sees the prospect of material profit improvement driving additional upside in due course.
DiscoverIE (LON:DSCV)
Unicorn’s Mackersie says DiscoverIE is an example of the FTSE 250 de-rating trend. For the uninitiated, DiscoverIE designs and manufactures customised electronic components for industrial applications. The Guildford-headquartered firm specifically targets markets benefiting from long term structural growth. These include medical, industrial connectivity, transportation, renewable energy and security.
‘Components are bespoke and designed specifically to meet customers’ unique requirements,’ explains Mackersie. This ensures long term repeatable sales throughout the life of their production.
‘Organic growth is enhanced by self-funded acquisitions which meet the firm’s strict investment criteria,’ he explains. Long-standing CEO Nick Jefferies and CFO Simon Gibbins have been in their positions since 2009 and 2010 respectively.
| Share price: 685p | Market cap: £648.4m |
| FTSE Sector: Electronic and Electrical Equipment | CEO: Nick Jefferies |
Source: London Stock Exchange
Mackersie says they have a strong track record of delivering organic growth. And they supplement this with well-integrated complementary acquisitions in DiscoverIE’s fragmented end markets.
The Unicorn man adds: ‘Under their leadership the company has delivered strong growth in revenues, profits and dividends. But the shares have de-rated in recent years due to the volatile macroeconomic backdrop and the general apathy towards UK small and mid caps. This has created an attractive opportunity to back a proven management team running a quality business capable of delivering strong future compounding returns.’
Moonpig (LON:MOON)
Jean Roche says online greetings cards and gifting company Moonpig (LON:MOON) stands out as being attractively valued. She highlights Moonpig’s unique company characteristics. ‘Among UK quoted companies, there is no other way to get exposure to this steadily growing market of online cards and gifts combined, with the associated valuable personal data treasure trove,’ says Roche.
Whilst Rightmove (LON:RMV) and Autotrader (LON:AUTO) hold 2.5 times-to-4 times the market share of their closest competitors, Moonpig stands at 6 times in the UK.
| Share price: 263p | Market cap: £784.4m |
| FTSE Sector: Retailers | CEO: Catherine Faiers |
Source: London Stock Exchange
‘A combination of top line growth of 6% plus, over 20% profit margins and 70% cash flow conversion (underpinning a generous share buyback) means that earnings per share grew 19% last year and can be expected to grow at a mid-teens level in the medium term,’ says Roche.
‘This implies a PEG (price to earnings growth) of well under 1 times, together with a generously covered dividend. With the fresh energy of a carefully curated new CEO, Moonpig, on its 6th birthday, could easily turn out to be, well….a gift.’
AG Barr (LON:BAG)
Thomas Moore co-manages Aberdeen Equity Income Trust (LON:AEI) alongside Iain Pyle. Moore says it is relatively easy to find cheap cyclical stocks. However, it is much harder to find attractively valued defensive businesses. Moore and Pyle remain cautious on domestic cyclicals given the impact of the UK’s challenging fiscal position on bond yields and the wider economy.
Against this backdrop, they recently added soft drinks producer AG Barr (LON:BAG) to the portfolio. They regard the Irn-Bru and Rubicon drinks maker as significantly undervalued.
‘We see the current valuation as highly attractive in the context of the company’s double-digit earnings growth potential,’ says Moore. The duo also expect AG Barr’s operational improvements to continue flowing through to earnings.
Since joining the business, CEO Euan Sutherland has focused on removing organisational siloes and increasing capacity at production sites in Cumbernauld and Milton Keynes. Productivity has been enhanced and AG Barr has also improved its ability to flex the size of cans and bottles to meet changing demand.
| Share price: 642p | Market cap: £715.9m |
| FTSE Sector: Beverages | CEO: Euan Sutherland |
Source: London Stock Exchange
‘We believe the savings generated can be reinvested into marketing and brand development, helping to support future revenue growth,’ insists Moore. ‘We also expect AG Barr to participate in the ongoing consolidation of the bottling industry. Bolt-on acquisitions such as Fentimans and Frobishers provide an additional source of earnings growth.’
‘Our investment process is designed to uncover value wherever we can find it,’ explains Moore. ‘For many years we found few attractive opportunities within the beverages sector, so we believe the market’s current scepticism has created a compelling stock-specific opportunity in a high-quality business with strong long-term growth prospects.’
