Smaller Companies: Opportunity for bargain-hunters

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SHARES in smaller companies are looking as soggy as a wet bank holiday weekend. There are few green shoots of economic recovery in sight, and equity prices have been in retreat over the summer.

The FT-SE 100 index, which measures share prices of the top 100 companies, has lost about 400 points because of the continuing recession and a weak pound.

This in turn has affected smaller companies' shares. In the past three months, the Hoare Govett Smaller Companies index has lost about 22 per cent, compared with about 15 per cent for the FT-SE 100-share index.

Since the beginning of the year, the Hoare Govett index is down about 14 per cent against an 8 per cent fall in blue chips, a considerable underperformance.

John Houlihan, smaller companies analyst at Hoare Govett, said: 'The HGSC index is daily establishing new lows for the year and is within 3 per cent of its post-crash low recorded in January last year.'

However, he said the correction had been overdone. 'It is true that the domestic trading environment is very tough, but not universally so.

'Plenty of smaller companies are moving forward, reporting higher profits and earnings and paying increased dividends.'

He added that the sector's underperformance reflected the market's lack of discrimination between high quality companies and those that are struggling.

However, the sector's weakness has opened up good buying opportunities for the long-term investor. Over the long term, smaller companies' shares have historically outperformed the market.

Stock selection remains the key to success. At 319p, shares in Rotork look good value. The company, which is one of the world's leading suppliers of valve actuators, increased profits by 11 per cent to pounds 4.8m for the half year to 30 June.

Actuators are electrically powered devices that control the opening and closing of valves. Rotork specialises in designing large computer-controlled actuators for the power, water and oil industries.

About three-quarters of its products are exported, shielding it from recession at home.

Brokers are looking for taxable profits of pounds 10.5m against pounds 9.5m last year. The company also has a strong balance sheet with net cash of pounds 12m.

The shares are trading on a multiple of 14 times prospective earnings and yield 4.5 per cent.