The rough ride experienced by shareholders of some of Britain's biggest companies this year has reki...
The rough ride experienced by shareholders of some of Britain's biggest companies this year has rekindled in many investors a desire to rediscover the smaller fry. The hundred largest companies within the FTSE 100 index may account for 82% of the total capitalisation of the stock market (as measured by the FTSE All Share Index), but they account for much less than 82% of the profits generated. Indeed, smaller companies continue to attract investors with their entrepreneurial cultures and ability to outperform the broader market.
During the year to date, the Hoare Govett Smaller Companies Index (excluding investment trusts) has risen by 6.97%. That compares with a fall of 0.36% over the same period on the FTSE All Share Index. True, much of this performance came from the strength of the technology, media and telecommunications (TMT) sector at the beginning of the year.
Between last December and March, there was as much money raised from flotations as in the previous 11 months. Almost all of these new issues were involved with technology of one sort or another. The share prices of these companies doubled, and seemingly doubled again. Few could sustain such valuations. Predictably, in March the bubble burst. Since then investors have become more discriminating and shifted their attention to firms with a viable strategy.
As a result, we have avoided companies in the business-to-consumer (b2c) category and those involved with incubator funds.
We have preferred instead to get our exposure to the expected growth in e-commerce by investing in fulfilment services of one kind or another, or in companies producing specific enabling software.
One such company is Stilo. Stilo specialises in XML (extensible mark-up language), which is fast becoming the standard language for e-commerce and data exchange across the internet. Stilo's system provides tools and services for people to use XML; it also enables them to produce and exchange data between computers. In addition, the company generates revenue from training and consultancy.
Companies in information technology have also come under the microscope of late. The sales of many companies in the sector have failed to bounce back as investors hoped they would. Profit warnings abound; and the excuse that customers have frozen spending because of Y2K no longer stands up.
As a result, we have sold the stocks of companies that have shown little or no organic growth in recent months; we have concentrated instead on those with content to offer or with fresh ideas. 4imprint is one such stock: over the past 12 months the company has transformed itself from a group based on print to a progressive internet distributor. Among its specialities is the supply of corporate gifts, a market that is growing strongly in the US, from where much of the company's trade comes.
While big may not necessarily be beautiful, the attractions of being too small are also waning. Companies with market capitalisations below £50 million are finding it increasingly difficult to justify the demands of remaining public; and investors are increasingly receptive to bids for companies of that size, especially where a substantial premium is offered for the shares.
Management buy-outs are also rising in popularity. An example is Peter Black, which supplies toiletries to Marks & Spencer. MediaKey, a book packager specialising in education and consumer titles, also announced recently that it had received an approach.
Few would complain about being paid large premiums for shares in small fry; indeed, many investors look for targets to invest in. But such investments have to be made at the right time. Telecommunications is an industry that is consolidating but also one that, so far as small-caps are concerned, we have largely avoided. True, the continuing deregulation of the local loop and of mobile telephony is likely to drive demand, but we remain wary of investing in areas where there are few barriers to entry.
One stock that we have identified is Telework Group, a company which specialises in computer telephone systems services and workplace solutions for management.
The company produces tracking systems, which allow employers to clock-in by dialling a phone number; this ensures that employees are in the right place at the right time, a valuable tool for road hauliers and transport operators.
There are signs that more corporate activity is to come. An increasing number of companies in the property sector are ready to buy back their shares or to take themselves private. Grantchester is one example of a buy-back that has had a positive effect on the share price.
Recently, the market has been struggling to find any sense of direction; growth areas are more difficult to identify and the tag of technology no longer guarantees spectacular returns. Many of the companies that we favour are in areas that we think will show secular growth. Selected financials offer good prospects.
Although the volume of stock market transactions by private individuals has fallen since the peak earlier this year, the shares of companies with valuable clients can still justify a premium. Companies like Liontrust and Towry Law, which offer advice and investment products, fall into this category.
Media continues to offer attractive opportunities, but it is hard to find good companies at the right price. Many providers of content are over priced. Radio, however, is an industry that still shows signs of good growth. Radio is increasingly popular as an advertising medium. The Radio Authority has invited companies to apply for digital multiplex licences, which will give them an opportunity to pioneer the take-up of
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