According to the work of Fama and French, small-cap stocks generate higher returns than their large-cap counterparts. Now, Fama and French compared entire portfolios, so picking any old small-cap stock will not necessarily work. However, if I can pick quality small-cap stocks favoured by the market, I might be able to boost the returns in my Stocks and Shares ISA.
I think £586.85m market cap Robert Walters (LSE:RWA) and Somero Enterprises (LSE:SOM), which has a market cap of £308.22m, are two UK small-cap stocks that could give me good returns on my money in the long run.
UK small-cap stock #1
Robert Walters is a specialist professional recruitment consultancy with a global presence. It focuses on finding and placing permanent and shorter contract staff for clients in the finance, technical, legal, sales marketing, and supply chain industries. It does this on request from firms, but also companies have outsourced their human resource department to Robert Waters, including payroll services.
The global pandemic was complex for Rober Walters. Jobs were lost during the pandemic and new hires dried up in all but a few industries. This explains the drop in 2020 revenues. However, revenues for the 2019 fiscal year also fell. But, I do note that the job market was tight in 2019; unemployment had fallen to its lowest levels since 1969 in the US.
Nonetheless, 2020 was not as bad as it could have been for Robert Waters. It pivoted to bio-sciences, logistics, gaming, and fintech recruitment, which was a more buoyant market. A new NHS contract was won in 2020, which should provide good recurring revenues. Despite the turmoil of the pandemic, Robert Waters has survived relatively unscathed and is well-positioned to participate in the next hiring cycle.
I think Robert Walters is a quality company. It has consistent operating margins and generates good amounts of free cash flow. The company has been consistently profitable since 2015, although profits dropped sharply in 2020. The market seems to agree, as it has bid up its price from 237p at the depths of the 2020 crash to 762p now.
It’s worth pointing out that the Robert Walters share price has recently set a new all-time high. Further outperformance does depend on the jobs market being ready for lots of movement and new hires. I think it is, so I am considering adding Robert Walters to my portfolio.
UK small-cap stock #2
Somero provides equipment to install high-quality concrete floors “faster, flatter, and with fewer people” to customers in over 90 countries. It also provides training, education, and support to its customers. It has several innovative product lines dealing with different cement applications.
Similar to Robert Walters, the Somero share price is close to its all-time high of 579p. This stock is in favour with the markets at the moment. And it is a quality company with solid and high margins for its industry, good free cash flow and earnings growth, and a track history of organic growth in revenues.
I think we are at the start of an upcycle in the contraction industry. This will benefit Somero. However, it’s worth noting that, like Robert Waters, Somero is a cyclical company. If the cycle does not turn up like I think it will, the market will notice and punish the Somero share price.