• Momentum is currently building to an even better 2024, but top-slicing on winners that command rich valuations could prevail as the market remains topsy-turvy. As investors continue to shop for growth and value for alpha generation in small-mid caps, the tendency of moving to a more attractive priced (below median valuation spread) space will continue to transpire. Other than thematic plays on various economic blueprint and master plans, we believe laggard plays on bottoming-out stocks will likely be another major theme realised on potential cyclical recovery and sector rotational.

• RHB Top 20 Malaysia Small Cap Companies Jewels 2023 achieved a 60% hit rate with an equal-weighted holding period return of 15.4% since our book launch on 16 May 2023, outperforming the benchmarking indices, ie FBM KLCI (6.9%), FBM 70 (13.8%), and FBM SC (11.2%). We also highlight that the broader market indices, particularly FBM SC and FBM 70, were lifted by positive news flows and policies – eg Johor developments or National Energy Transition Roadmap (NETR) – that emerged predominantly in 2H23, subsequent to our Jewels selection. Detailed information on the respective stock performances can be found on page 6.

• 2023 ended on a high note. The FBM 70 (+12.3%) and FBM SC (+9.6%) outperformed the FBM KLCI (-2.7%) – thanks to the strong interests in the sector in search for growth as depicted in the improved trading activities, especially in 2H23. The better performance of some stocks in 2H23 so far has been driven by sectors such as power, construction, and properties, thanks to the Johor thematic play and superb runs from few individual stocks. Moreover, certain corporate exercise, value-unlocking, and thematic play trends were also among the main drivers.

• Strong interest returns. There has been a strong pick-up in trading interest for the FBM 70 and FBM SC – which printed growth of 43% and 12% in 2023. Higher retail participation (c.27%) in 2023 also contributed to the pick-up in volumes. Interestingly, both trading value (+26%) and volume were much stronger for the FBM 70 vis-à-vis the FBM SC and FBM KLCI, helped by strong investor interest in the conglomerate, consumer, construction, industrial, property, and utilities sectors. Nonetheless, trading value for the FBM SC contracted by 6% despite a 12% growth YoY in trading volume – this suggests more micro-cap stocks are of the interests in the small cap space.

• Supportive valuation spread. The FBM SC is trading at a discount (1-2x) to the FBM KLCI and is below the 10-year historical median valuation spread, adding another compelling reason to explore this space for alpha returns. Conversely, the FBM 70 is trading at a premium (+4x) to the FBM KLCI – above the historical median – thanks to the strong run-up of the mid-cap stocks over the past years. Meanwhile, based on our stock coverage universe (Figure 11) – small-mid cap stocks are now trading at par to the FBM KLCI vis- à-vis FY24F growth of 13% vs +9.2%. While valuation may not be the most attractive following the recent run-up, we do believe there are still various bottom-up opportunities in these spaces for alpha generation given the stronger growth on offer.

• Strategy. While the small-mid cap space is often preferred for its higher growth prospects, a balanced pick, combined with value- and growth-focused stocks is appropriate in the current environment. The recent riot in the smallcap space pertaining to some specific stocks should not deter investor confidence in looking for good fundamental stocks. As such, a focus on earnings quality, margins preservation, cash flow, and yield generation is paramount, especially on the backdrop of tense geopolitical conflict, cost escalations, and demand uncertainty. Industries that could be in favour: i) Consumer, ii) construction, iii) logistics, iv) oil & gas, v) property, vi) technology, and vii) green energy. Economic recession, persistent high interest rate environment, earnings disappointment, liquidity issues, political instability, and ESG-related risks are things to watch out for.

Source: RHB Securities Research - 30 Jan 2024