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Investment view

Two magazines have recently published lists of companies delivering rapid growth – one in the US and one here in Britain. The rather depressing element in both of them, so far as I am concerned, is that I have not heard of any of the companies. Take the top slot in Fortune magazine&#39s 100 fastest-growing companies list. 4Kids Entertainment produces Pokémon films and holds licensing rights to use these little creatures on T-shirts, backpacks and school supplies in the US.

With grown-up children, I confess the Pokémon craze has passed me by. From an investment point of view, that may be just as well because 4Kids&#39 shares have fallen over the past year despite the fact that earnings per share have grown by 312 per cent each year over the past three years. To be fair, you would have trebled any money you invested three years ago, even if the past six months have been more difficult.

More encouraging is the fact that not all these fast growing companies are in the technology or entertainment sectors. The fifth-rated business in the US is a company making magazine display racks for supermarkets. How on earth, you might wonder, does Source Information Management succeed in delivering revenue growth of 125 per cent a year in such a basic industry? The answer is by tracking sales and marketing information and selling it to magazine publishers and retailers. And there is a techy connection – it does it online.

The important thing about all these businesses is that they are relatively small. The bigger you get, the harder it is to deliver impressive growth statistics. Even companies like Microsoft find it difficult to sustain momentum. Rentokil, one of the great success stories in this country, had its share rating savaged when it was forced to concede the growth target it had maintained for many years of 20 per cent a year would have to be abandoned.

Yet investing in smaller companies is often fraught with difficulty. Until comparatively recently, popular wisdom had it that you would do better in smaller company shares, despite the risk element, but that came to an end less than a decade ago. For a large chunk of the 1990s, smaller companies underperformed, in part because of the flow of money into quantitative funds and, in particular, index-tracking vehicles. At least the technological boom refocused attention on smaller companies, which are again delivering above-average returns.

I am a sucker for an interesting small company and have had my fair share of successes and failures. But if, out of five businesses you back, one multiplies ten-fold, one goes bust and the other three do nothing, you will not have done too badly.

What constitutes a small company is a matter of debate. I read an interview with a US fund manager for whom smaller companies are those with a market capitalisation of less than $1bn. That is £700m on this side of the Atlantic, which includes some pretty fair-sized businesses. Even in London, opinions differ. Although there is an FTSE small cap index, we tend to plump for any company outside the FTSE 350 index as being small cap. This gives quite a wide constituency as it is more than 80 per cent of the companies quoted in London by number but a relatively derisory percentage in terms of market capitalisation. It also avoids the confusion that results from having a small cap index where the biggest company is worth six times the value of the smallest in the FTSE 350.

The debate will continue as to whether investors are wiser accessing the smaller companies market through funds or by trying to pick a few winners. For those in the industry, I suspect the latter approach will prevail. For the investor who lacks the ability to keep their finger on the pulse of the City, researching the fund managers must be the better option.


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