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Why Invest in Smaller Companies?

For a number of reasons, on average, smaller companies outperform larger companies in the long term. Research by Dimson and Marsh with reference to the Hoare Govett Smaller Companies index and the London Business School MicroCap Index shows that, in the U.K., in the period 1955-2000, the average smallcap company beat the market by a factor of 2.83 while the average microcap stock outperformed the market by a factor of ten to one.  Subsequent declines in global equity markets and reversal of the size-effect have brought these multiples down but, over a long period, small and micro caps have outperformed the market massively.

With mining companies in particular there are a number of very good reasons why this generality should apply:

  1. The simple argument that it is far easier to double or quadruple a company capitalised at £10m-£100m compared with, for example, BHP Billiton, capitalised at £85 billion. An astonishing example is Norseman, the West Australian gold producer, which after a financial re-structuring, rose from 1.75p to 33.75p between 1st January and 31st May 2009. This is a rise of 19 times compared with BHP, which rose just over 12% during the same period. The performance of Norseman is exceptional but it illustrates what can happen occasionally with very small gold companies. More typical examples are Centamin which has doubled and Medusa which has almost trebled during the same period.

  2. A major new discovery has a disproportionate effect on the market capitalisation and share price of a smaller company.

  3. Many majors are likely to make acquisitions to enhance their reserve position. Smaller mining companies with large, proven resources should be the major beneficiaries of this trend.

  4. New finds are frequently understated by virtue of the regulations that only proven reserves and measured and indicated resources can be confirmed. Step-out holes in several different directions around a find usually discover further resources with a consequent impact on the share price.

  5. With major companies like BHP Billiton a proportion of their assets are in politically risky areas. Selective investment in junior miners will avoid undesirable areas, such as Russia and the Middle East, with their ongoing risk of expropriation or armed conflict.