Mind the gap for little 'uns

Although the small-cap share index is hitting new highs, bargains still abound among the stock market's little 'uns.

Although the small-cap share index is hitting new highs, bargains still abound among the stock market's little 'uns.

Indeed, last week Perpetual, the fund manager, underlined the investment merits among the small players by pointing out that the valuation gap between large and small companies is at its widest for five years.

In a sense, small-company shares are still suffering from the institutional sell-off which ravaged their ranks in the early Nineties as the country reeled from the impact of devastating recession.

Until then, they had traded at higher, or at least on similar, ratings to blue chips. In fact, it was once widely assumed real investment growth was easier to achieve on the stock market undercard than among its leaders. Spotting future blue chips, like a Hanson, was the sure way to score.

The Perpetual research underlines how poorly small-caps have performed in relation to blue chips since the stock market's dramatic recovery after Britain quit the ERM in 1992 when Footsie was 2,400 points.

The 100 blue chips and to a lesser extent, the 250 constituents of the mid-cap index, have been the major beneficiaries of the revival. The tiddlers have been left out in the cold.

The reluctance of the big investors to get deeply involved in the smaller end of the stock market is mainly responsible for the great investment divide.

Their caution is easy to understand. They need to trade in bulk and have often been caught on the hop as prices have moved against them.

They say the markets in shares of small companies are often too narrow to accommodate a significant transaction and they have been forced to complete deals at ridiculous prices.

Merger activity among fund managers has also reduced the desire to get involved in shares outside the top 350.

But I believe until more institutions are prepared to take a positive view about small-company plays, the little 'uns will remain the great unloved, unlikely to recapture their former glory.

But they are, on any realistic investment measurement, remarkably cheap. With such undemanding ratings they should continue to move ahead, perhaps even starting to narrow the investment gap highlighted by Perpetual.

Fund managers say the steady flow of overseas takeover bids and management buyouts, mostly cash-funded, is a telling illustration of the value lurking on the stock market undercard.

Most of the no pain, no gain portfolio constituents are tiddlers, some too small to be included in the small-cap index.

Springwood, the leisure group, was an early member of the portfolio and although its shares have failed to hold their best level - 244p - they have managed to remain above my buying price of 131.5p.

I am disappointed by their fall from grace but I remain confident the group's strategy is sound and profits will continue to advance. Half-time profits were 13.6 per cent higher at £1.3m; more than £3.5m against £2.73m should be possible over the full year.

But the fall in Springwood's shares is modest compared to the plunge achieved by Deep Sea Leisure, a former portfolio constituent.

Its shares are 47.7p with a rescue rights at 30p a share signalled. They have been as high as 390p and were tipped out of the portfolio at 102.5p against, I am saddened to recall, a 250p buying price.

The painful decline represents yet another telling illustration of the stock market's inherent ability to detect a company's difficulties. Deep Sea, a fledgling aquarium business, traded below expectation but managed to produce a £557,000 pre-tax profit in the year ending February.

But it was unable to meet its scheduled debt repayments and breached its banking agreements. The debt has now been restructured and, to repay a bridging facility, £2.5m is being raised through the emergency rights issue.

Deep Sea is a salutary example of the dangers which lurk when you choose to back a young and ambitious company.