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The value in smaller companies

Richard Power - 11 March 2010

Markets continue to be described as volatile, the translation being ‘investors are finding it almost impossible to identify a directional trend'. There are reasons for this; some from far flung locations such as China and Greece, others are closer to home, and therefore more relevant to the smaller company index in the UK. The first concern occupying the minds of investors is the general election, and the unquantifiable implications of the numerous outcomes. The second is the much muted double dip. Were it to happen, there is unlikely to be much evidence this side of the election, so smaller company share prices have been left to drift in the meantime.

Here lies the opportunity. Rather than add (what little we can) to the lofty subjects above, our job is to identify, research and invest in professional management teams of small companies that are successfully growing their profits, even in the prevailing economic conditions. And there are plenty of them. The news flow from smaller companies over the first two months of 2010 has been positive. Buoyant trading updates, upgrades to earnings and increasing acquisition opportunities have been the messages. The AiM market is very much open for business. In February alone we met with 18 companies looking to raise new funds on AiM for either expansion capital or acquisition funding. As a result of the macro uncertainty, growth companies are trading at historically very low valuations, and this store of value has been building all year as earnings rise and share prices creep sideways or backwards.

A good example is Albemarle & Bond, one of the UK's largest chains of pawnbrokers with 123 branches. Albemarle & Bond is a proper growth story. It has achieved over twenty years of uninterrupted profits growth and has been quoted on the AiM market since 1996, so should be well known to investors. For the financial year ending June 2007 the company reported a pre tax profit of £7.2 million. Last week the company announced half year profits of £10.8 million and the company remains firmly on track to achieve a profit of over £20 million for the year to June 2010. The company has trebled its profits so you would have been forgiven to have expected the share price to have gone up - particularly as the underlying economic conditions remain favourable for the company. Well no, it hasn't. The share price hit 270p when the company announced its profits in 2007, and today the share price is 264p, valuing the company at just £140 million. This is what we are referring to when we describe the store of value amongst smaller companies. Were Albemarle & Bond to trade on a similar earnings multiple to 2007 (the growth multiple it deserves), the share price would be over 450p.

May Gurney, which provides infrastructure services and essential maintenance to the road, utility, rail and waterways networks is another good example. Recent contracts wins have been more national in scale and the company has exciting growth prospects in the waste services sector. May Gurney reported a profit of £14.9 million for the financial year to March 2007, and since then has built up a £1.4 billion forward order book and cash of £25 million on its balance sheet. Three new contracts wins worth over £350 million in the water sector announced this year give further visibility to the order book. Profits for the year ending March 2010 are expected to be £21.5 million, over 40% higher than three years ago. The share price however is 25% lower.

This is why we're excited and believe smaller company equities offer exceptional value. Once many of the macro uncertainties are confronted, the value in smaller companies will be recognised - potentially quite quickly.

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