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Your Money > Investing Comment Articles > Size matters
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By Richard J Hunter, Hargreaves Lansdown
Within the FTSE100, things are not too different. The old Given that these stocks, in theory, represent the biggest and the best, why should this be? There are any number of reasons. Renowned stock market commentator Jim Slater was once famously quoted as saying 'elephants don't gallop'. He was reflecting that the large companies of tomorrow are often the small companies of today and, at the same time, whilst many of today's largest companies will continue to grow, they are unlikely to sustain the same exciting rates of growth. Compare, for example, the following. In the last ten years, current FTSE100 constituents such as Capita (+763%), Shire Pharmaceutical (+423%) Persimmon (+400%) have progressed to being mature companies from much more humble beginnings. At the same time, however, many long existing FTSE100 constituents - although to be fair each of the following have had their own major challenges over the period - have seen rises of 47% (HSBC), 32% (AstraZeneca) and 24% (Marks & Spencer) - (source: ShareScope). These may be extreme examples but they do tend to underline the fact that growth is inevitably slower - and perhaps expectations that much higher - for the UK's leading companies. In addition, there are certain of the megacaps whose past acquisitions are not generally agreed to have added much value to their businesses, for which they continue to pay in share price terms. Deals such as Vodafone (Mannesmann), Glaxo (SmithKline) and even the Royal Bank of Scotland (some 25 deals in 5 years) have had varying levels of success. More recently, however, some have begun to question whether favour should be shifting towards the largest valued companies, and not just the megacaps. Historically, there have been occasions when the large caps have outperformed small and mid-cap stocks, even though on fundamentals, and in the longer term, this is not necessarily logical. The question now is whether the gap in value between the large caps and the rest has risen to a level which is overdone. Over the last three months, both the FTSE-All Small index (+0.87%) and the FTSE-Small Cap index (+0.51%) have underperformed their large cap rival, with the FTSE100 index having risen by 4.5%. By way of comparison, and although the significance of the US Dow Jones index reaching new all time highs is being passed off as relatively insignificant by many market commentators (+8.6%), a similar situation has occurred there, with the Dow US Small Cap index also underperforming (+4.6%) in relative terms. There are some interesting potential reasons for this. Up until now, the largest companies have been seen as "bid proof", and therefore have not enjoyed some of the froth so prevalent elsewhere in the market. This may still, indeed, be true, for the megacaps, but the surge of the private equity industry - having already cast an eye over the smaller to medium array of companies - have switched their attentions to the larger caps, as indeed have foreign companies. The likes of O2, P&O, BAA, Alliance Boots, and BOC have all disappeared from the FTSE100 and there may well be more to come. With this private equity speculation comes the possibility that the management of such companies are considering ways in which to extract any such perceived value within their companies, but avoiding direct involvement via the private equity industry - board directors' jobs may often be at stake. Such avoidance or protection techniques may be materialising in one of two ways. Firstly, large cap corporations have been actively discussing and occasionally executing potential mergers within their respective industries. Some examples might include Reuters and Thomson of Canada in the media arena, or ICI and Akzo in the chemicals sector. Secondly, rather than letting private equity groups add debt to their balance sheets post any takeover, managements are doing the so called 'gearing up' themselves. In the US a recent example comes via the DIY retailer Home Depot borrowing an additional $12 (£6 billion) in order to finance a $22.5 billion share buy-back scheme. Share buybacks are earnings enhancing and generally price supportive. Another reason might include some broad investor risk aversion. With interest rates on the rise in many parts of the world, the larger diversified companies of a particular economy should be able to weather any potential downturn in consumer sentiment brought on by the rising cost of borrowing. Historically large cap stocks are looking particularly undervalued compared to their smaller peers - and these are companies which tend to have the most stable earnings, highest dividend yields and the highest returns on equity. Watch this space. Useful links: |
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