We’ve seen a solid start to 2023, with the market as a whole already up by more than 6%. Some of the gains in the small-cap space have been far more impressive.

Those that have enjoyed the biggest recoveries have tended to be ones that have reported:

  • Strong balance sheets
  • Positive (or at least improving) operating cash flows
  • Sustained sales momentum

With the days of easy money likely over, and with companies facing tougher economic conditions, that’s probably not surprising. This is not an environment in which you want to be reliant on the kindness of capital markets.Companies are, of course, entirely aware of this stark new reality. Which is why layoffs and other cost-cutting measures are an increasingly prominent focus for many businesses.

But be careful not to cheer too loudly for management teams professing a new found thrift. As they say in the commercial world; no one ever cut their way to greatness.

We shouldn’t forget that only those with the most bloated cost structures have much to gain here. In other words, if you can materially reduce costs without impacting future growth, it’s a tacit admission of previous ill-discipline. 

Great companies run lean even in the best of times.

Remember, too, that there are costs associated with cutting costs. Redundancy and restructure expenses may be dismissed as “one-offs”, and excluded from “underlying” earnings, but they are nevertheless very real.

And if you’re overly aggressive in pulling back on things such as R&D and other investment initiatives, you tend to hobble your future prospects. Saving a few bucks in the current period could end up costing you a lot more in the long run — especially if you’re up against more far-sighted and better capitalised competitors. 

We should be careful not to generalise too much; every company faces its own unique set of circumstances. And some tough decisions are often unavoidable.

Just beware of management teams that shift the narrative to suit the latest market fashion.

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