Fool's Eye View

[ June 16, 2000 ]

Small and Ignored

By Rob Davies (TMFEssex)

Carburton Street, London -- Barclays Bank (LSE: BARC) tells us, through its adverts, that you have to be big. Interestingly it doesn't say why, it just says that "bigness" is a good thing. For a steamroller, or an icebreaker, I agree. And the stock market certainly likes big stocks. It is no coincidence that our largest companies are also some of the most expensive. As a sweeping generalisation, the market is happy to pay a premium for size.

The reasons for this bias have been discussed elsewhere, but essentially the market likes the liquidity -- the ease of dealing -- in larger stocks, and tracker funds obviously direct more fresh money at the bigger companies than at the smaller ones. Even our local value investing hero TMFPyad has a £100m threshold he won't go below because he feels there is too much risk.

In general I agree with Pyad, so I find it strange to be taking a different stance to him on this issue. Over the last few weeks I have spent time looking at my portfolio and doing a few deals. The reason for that, I hasten to add, is because one of my holdings was taken over thus freeing up some cash which then needed reinvesting.

But I could see nothing that attracted me in the bigger stocks, either in the value category or in the growth stocks. So, by necessity, I found myself looking at some of the smaller companies. It is true to say that some were already in my portfolio and had dropped down to very low levels, but as I looked at them again with a view to topping up I was staggered at the valuations.

These were some of the companies I looked at two weeks ago, but the valuations are as of today. Some of these stocks have moved substantially in the intervening period: then again, some of them haven't.

Stock                Mkt Cap    P/E    Yield  P/Book
                          £m              %
RJB Mining (LSE: RJB)     98    7.6     11.1    0.4
Somerfield (LSE: SOF)    269    4.0     18.7    0.4
Halma (LSE: HLMA)        383   12.4      3.4    3.3
Inchcape (LSE: INCH)     222    4.4     20.5    0.4

Some of these companies have had well-publicised troubles and perhaps deserve to be sold down. Nevertheless, one gets the feeling it might be a little overdone. In the case of RJB Mining (LSE: RJB) the current share price is twice what it was two weeks ago, yet it still stacks up on most value measures.

In the end I decided to buy another stock altogether. Not a value play but an out-of-favour growth stock and, even though it was a very modest trade, I was most surprised when the trading screen told me it was larger than normal market size. From then on I started looking at the trading volumes of some of these sub-£300m stocks more closely. The results were startling. The typical trades are a few hundred shares, rarely are they greater than a few thousand shares. It is obvious that it is all private investor business and that the institutional investor has totally abandoned this sector. A fact reinforced by the paucity of analyst forecasts and recommendations for these shares.

To me the message is clear. The big fund managers are only interested in going with the herd. They don't mind getting it wrong if everyone else does, but they are not going to go out on a limb to look for hidden value. Brokers ignore them because the potential corporate business is too small and with commission levels so low they can't recover research costs from trading. So basically the field is left clear for the private investor to do his own research and pick up the bargains.

All we need now is more liquidity. But isn't that what day traders are for?