Smaller companies are 'undervalued'

The valuation gap between large and small companies listed on the London stock market is at its largest level for five years, according to an analysis by Perpetual, the fund management group.

The valuation gap between large and small companies listed on the London stock market is at its largest level for five years, according to an analysis by Perpetual, the fund management group.

The FTSE 100 may still be well off its year-high, but UK investors still appear to believe big is beautiful. Perpetual has found that on the key valuation measure of share price/earnings per share ratio, smaller companies are valued on average at 30 per cent less than large companies, the widest such discount since 1995.

Smaller companies often tend to be have a stronger entrepreneurial culture and less bureaucracy than their larger counterparts. Perpetual uses the same definition of small as that adopted by the Hoare Govett Smaller Companies Index, which includes almost two- thirds of the so-called mid-capitalisation stocks valued between £300m and £740m.

While many of the companies in the smaller companies bracket are run by former FTSE 100 executives and are often global businesses, investors seeking these qualities in a stock have preferred to put their money into larger companies, which are perceived as having stronger balance sheets. That has left many smaller companies trading at discounts to their net asset value.

John Sweet, smaller companies fund manager at Perpetual, said that the valuation gap is actually good for funds focusing on the sector, which tend to benefit when consolidation takes place because of their concentration in undervalued situations.

"Global market share, realisable assets and experienced management are some of the major factors we analyse. But we also place attention on sales-growth stocks in technology and media as well as recovery plays in other sectors," he said. "Smaller companies are positively linked to real domestic economic growth. These groups are not the same as private smaller companies such as corner shops or local wine bars, they often employ thousands of people."

The perception that smaller companies were in need of financial support is misplaced, he added. "Smaller companies' balance sheets have improved significantly over the last ten years, thanks to positive cash flow generation on the back of better stock control using new technology," Mr Sweet said.