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Small caps in U.S. and U.K. deserve a closer look
Thom Calandra's StockWatch



LONDON (FTMW) - Small stocks on both sides of the Atlantic, while beating the performance of larger companies thus far this year, are still a neglected bunch, market pundits say.

Shares of small companies, for example, sell for far lower multiples of profits and revenue than their larger cousins. In some surveys, shares of companies with a market capitalization of $1 billion or less sell for as little as a third of the price-earnings multiples of larger companies.

"My contention is that there is terrific value among small and mid-cap companies in the U.K. market and a very serious anomaly because institutional managers have a very blanket approach to investment," says Neil Thapar, city editor of Sharecast.com, a regulated financial Web site in London. "A lot of value is being ignored below the FTSE-100 and FTSE-250 indexes."

Small stocks have nothing to be ashamed of this year.

Small-cap mutual funds in Britain gained 1 per cent in this year's first three months, surpassing all stock-fund categories. The FTSE SmallCap Index of 410 companies has risen 10 percent since hitting a low in early April. The FTSE-100 Index of Britain's largest companies, meanwhile, has risen just 7 percent in the same span.

In the U.S., shares of small companies as measured by the Russell 2000 Index have risen 2 percent this year against a 4 percent loss for blue chips as measured by the Standard and Poor's 500 Index.

Thapar, who dispenses "share tips" along with a panel of market writers at Sharecast and at Durlacher-owned sister Web site Nothing-Ventured.com, says British fund managers are too complacent.


"One of the excuses they make is that they cannot buy enough stock because of a lack of liquidity in small issues, but I see that as sheer laziness," said Thapar, a former financial writer for The Mail on Sunday.

To be sure, American investors often voice the same complaints about the performance of small stocks, which, notwithstanding a valuation surge in the early part of last year, get little attention from professionals on Wall Street, fund managers in Boston and brokers in London.

"I think most people are comfortable with the names they recognize, whether it is in the stock market or on the supermarket shelves," said Glenn Cutler, a former California fund manager who specialized in shares of small companies. "The stock market is becoming much more fragmented these days, and that leaves many profitable but depressed companies in niche markets."


Joe Duarte, a Texas fund manager and author of "Successful Biotech Investing," says most investors are barraged by news about giant companies -- "the Cisco nonsense," he calls it. Meanwhile, smaller companies' stories go begging for attention.

In London this week, Thapar calls this the BT effect. British Telecommunications, carrying $40 billion of debt, will seek a break-up via an $8.3 billion rights issue, the company said Thursday. "Many of these London fund managers are now being caught with their pants down, buying giant telecom stocks like BT at ridiculous levels last year while ignoring small companies," said Thapar.

American and British investors - and fund managers -- have a wide range of small stocks from which to choose. They include those on the London Stock Exchange and on the Alternative Investment Market, an exchange for British companies whose shares often sell for a few pence. In the United States, small stocks can be found across the three major stock exchanges, Nasdaq, the New York Stock Exchange and the American Stock Exchange.

Some examples:

Thapar points to Ferraris Group (UK) - a U.K. medical products maker whose half-year pretax profit rose 70 percent. "It is likely to grow its earning by 15 percent a year long term and yet it trades at a P/E of 11. There is no earthly reason why institutions should not be buying this stock." He also points to Convergence Holdings (UK), whose top executives include Mike Luckwell, an investor who backed successful media companies WPP, Carlton and Hit Entertainment. Convergence, which trades on the Alternative Investment Market, hopes to build a media library of images and deliver them to professional agencies, much like Getty Images (US) in the U.S. has done.

Cutler in California wonders why shares of profitable Israeli company Camtek Ltd. (US) get no respect. "This Is just a neat company that has optical inspection systems to find defects in circuit boards during their manufacturing process," he said. "The company just reported a nice profit in a quarter when many tech companies struggled. It has a clean balance sheet, no debt and few people have heard of them." Camtek, which listed on Nasdaq last summer, sells for a P/E of 7.

Duarte points to Biopure Corp. (US), also on Nasdaq. "Its blood substitute has performed better than expected in clinical trials and looks to be headed for the Food and Drug Administration's approval panel soon," says Duarte, a medical doctor. "This is significant since there is no other real contender for a useful blood substitute in the world. One product, Hemopure, which is purified cow hemoglobin, is approved for use in South Africa. "That sets the company up for either huge profits or a takeover from someone like Baxter (US), who has been trying for years to come up with a blood substitute." Note: Several other companies are developing blood substitutes, including Alliance Pharmaceutical (ALLP) and Hemosol (HMSL), both trading on Nasdaq.


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Thom Calandra is Editor-in-Chief of CBS MarketWatch and FTMarketWatch.com.