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The Hoare Govett Small Companies Index Report

19 Feb 2010

Mid and small-cap companies had their best share price performance since 1977, according to new research by Professors Dimson and Marsh.


The HGSC Index report, published today by The Royal Bank of Scotland plc (RBS) and London Business School professors Elroy Dimson and Paul Marsh, shows that in 2009 mid- and small-cap companies had their best share price performance since 1977. This was only one of the many striking reversals from the previous year.

Stephen Ford, Head of UK Mid Market Equities, RBS, said:
“Following the strong outperformance of the HGSC index in 2009 a period of consolidation is expected in the short term. However restructuring benefits, coupled with robust balance sheets and top line appreciation, should underpin earnings upgrades and further outperformance over the course of the year.”

The RBS HGSC Index measures the performance of the lowest tenth by value of the main UK equity market. Launched in 1987, the index has a unique 55-year back-history. In 2009, the HGSC gave a total return of 54.2%, which is 24.1 percentage points above the FTSE All-Share. The HG1000 XIC “minnows” index (which covers the bottom 2% of the market, ex-investment companies) had an even higher return and beat the FTSE All-Share by 45.7 percentage points. (Figure 1).

The authors of the report, Professors Elroy Dimson and Paul Marsh, said:
“The HGSC staged a major recovery in 2009. Mid- and small-cap companies thus ended the decade with cumulative, 10-year performance that is among the best of the major UK asset classes. An investment 55 years ago of GBP 1000 in the HGSC, with dividends reinvested, would today be worth GBP 2.6 million, as compared to GBP 0.5 million if the investment had been in the FTSE All-Share.”

Globally, small-cap companies performed well during 2009 in all 26 markets researched by the authors. The worst performers of the previous year tended to be the best in 2009. Across 26 countries, the small-cap premium (the excess of small-cap over large-cap stock returns) averaged 33%. (Figure 2)

Although the last decade has been dubbed a lost decade for equity investors, this has not been true for small- and mid-cap investors. From 2000–2009, the HGSC, ex-investment companies, had a 66% return; the FTSE250 returned 91%; the Dimson-Marsh MicroCap™ index had a 102% return. Small-cap /mid-cap stocks outperformed large-caps, cash, bonds and investment property. (Figure 3)

In last year’s report, the authors said that when recovery came, high beta stocks and sectors—which were the worst hit in the 2008 downturn—would perform best. This is precisely what happened. In 2009, smaller companies with a high beta returned 81% while low beta stocks returned just 25%. (Figure 4).  When comparing 2009 with 2008, it was a case of “the first shall be last and the last shall be first”.

Although stock markets recovered sharply in 2009, this came too late for many companies and 2009 saw a record number of listed companies becoming valueless. (Figure 5). It was also the quietest year since the launch of the HGSC for AIM IPOs and for fully listed IPOs and acquisitions. 

With bank borrowing in short supply, many companies have cut dividends. More than half of index constituents reduced their dividends or already had a zero payout. A quarter of them cut their dividends by 50% to 100%. In 2009 it became “respectable” to cut dividends. (Figure 6).

Looking to the future, the HGSC enters 2010 with a dividend yield of 2.67% and a P/E ratio of 13.23 (ex-investment companies, 11.22). This may be compared with the All-Share’s 3.20% yield and 13.22 P/E.

Other findings:

Reversal of the profitability of momentum trading (in 2009, momentum had its worst year since 1955); reversal of the value effect (in 2009, growth stocks outperformed value stocks); 

Reversal of the performance of new entries to the HGSC (companies that became small enough to enter the index subsequently outperformed); 

Reversal of the HGSC ratings decline (in 2009, small-cap P/Es went up by 75%); 

Reversal of the small-cap yield gap (during 2009, small-cap yields fell to below the All-Share).