Small Firms Still To Show Form

Sydney Morning Herald

Wednesday January 18, 1995

DAVID TRIBE

AT the beginning of 1994, analysts, chartists, brokers and other sharemarket pundits were saying that big companies were beautiful and small were sensational. A year later, whatever the pundits are saying, many investors feel that big is a bugbear and small is suicidal.

Apart from the chorus of fund managers and stockbrokers warbling that happy days will soon be here again, some year-end media comment has polished the silver lining on 1994's investment clouds by highlighting the year's winners, many of them small companies.

Some were relatively recent floats. These included Hargraves Resources, Ranger Minerals and Charters Towers Gold. But some "old favourites" came back from the wilderness.

Prominent among them were members of Mr Joseph Gutnick's gold-diamond stable including Centaur Mining, Australian Gold Resources and Johnson's Well Mining.

Unfortunately, as the table shows, shares whose prices multiplied were more than counterbalanced by those whose prices divided spectacularly.

The losers' table lists only companies well-known to share traders and widely spruiked at the beginning of 1994 - or throughout it. Several others less known did as badly, or even worse.

What are the likely reasons for this debacle, and what's the prognosis? After the crash of October 20, 1987, many investors found there were simply no buyers for small companies at any price. Especially hard hit were institutions with large parcels of shares to offload.

After 1989, small companies were particularly hit by the incipient recession - especially when Australian interest rates hit a prime of 20 per cent plus a "risk margin" for small operators.

With the sharemarket in the doldrums, it was impractical to go to shareholders for more cash. So the cry arose that "big is beautiful" and the All Ordinaries index, based on market capitalisation and normally including around 300 companies, eventually came to include only 240.

In November 1992, with Australia slowly emerging from recession, a new bull market began. Towards what in hindsight can be seen as its peak in February 1994, small companies were swept up on the bandwagon. Many of these were high-tech industrials and explorers for gold and diamonds. As usual, "fundamental" reasons were sought for this change in sentiment, and were easy to find.

Australia had long been in the forefront of scientific research and was beginning to show some aptitude for development and marketing, especially overseas.

New techniques were making it easier and cheaper for small explorers to assess their large acreages and begin production from what had hitherto been marginal reserves. Commodity prices overseas were starting to rise from long-term lows.

Yet these arguments counted for little when sentiment reversed in 1994, foreign funds fled and local institutions again turned to "quality".

Australian Stock Exchange (ASX) figures for 1994 give some indication of the nature of the downward trend. All Ordinaries (currently 317 companies) down 12 per cent; All Resources down 2.7 per cent; ASX 100 down 11.9; 50 Leaders down 10.8; 20 Leaders down 9.7; All Industrials down 16.4; "Small Ordinaries" (a new index being developed to cover the 217 companies within the All Ords but outside the ASX 100) down 12.2.

These figures indicate that, while the big institutional investors gobbled up shares in the biggest companies, they favoured resource stocks over industrials. Moreover, smaller investors stayed relatively loyal to the "small" industrials, which fared better than the top ones.

This seems to confirm the continuing faith of stockbrokers Bain and Company in smaller companies. Hitherto, it has produced a Mid Cap Monthly listing, likely to become twice-yearly in 1995, compiled by Amanda Miller and Matthew McNee.

This features around 60 "small and middle capitalisation" industrial companies that Ms Miller says "came into our view either because Bain's was particularly keen on them or because Bain's was involved in their float".

She notes that in 1993 "a lot of new institutions were setting up new portfolios and looking to establish themselves as high-growth funds to beat the average". So they chose shares outside the mainstream.

"In early 1994 one saw perhaps a peak market performance of these companies relative to the rest of the market," she says. "Since then there's a perception that small companies have suffered unduly, derived from the fate of high-profile companies like ISR, but it's not borne out by a larger sample." Bain remains very positive and recommends, in the under $50 million category, Techway, Scientific Services, Plumbing World and JNA, she says.

But what are small companies? Potter Warburg Securities produces a quarterly Smaller Companies Compendium containing about 90 companies capitalised up to $500 million. Bain's Mid Cap Monthly embraces companies below $400 million. It has no lower limit but contains few below $20 million. Ms Miller deems "small" to be under $50 million, but Mr McNee sees it as under $100 million.

Clearly most brokers referring to small companies aren't thinking of "penny dreadfuls", where the greatest carnage has occurred. These are mostly gold and diamond explorers. Despite good initial discoveries and the passage of many to producer status, they've suffered from uncertainty over the price of gold and the prospectivity for diamonds of kimberlite pipes. Fiascos in the promotion of Mt Burgess Gold and Cambrige Gulf Exploration have hit the whole sector.

In this area, sentiment can change almost overnight.

A director and former chairman of the Australian Shareholders' Association, Brendan Birthistle, says investing in small companies is a high-risk venture, particularly for recent floats.

"Investors found that too frequently most of the money raised went straight into the pockets of promoters, and that's why so many turned out to be duds." But he adds that he is a fan of small companies, and points out that "equity trusts like Rothschild, Mercantile Mutual and AMP that specialise in smaller companies have done very well".

He thinks direct investment is for "sophisticated investors who do their homework, know the business invested in and check out the background of directors".