From little things, big things grow

Thanks to ongoing market turmoil, there's real value to be found in smaller companies, writes David Potts.

Thanks to ongoing market turmoil, there's real value to be found in smaller companies, writes David Potts.

In this market, size counts, and the smaller the better. Not so much in the sense of the biggest stocks shrinking in value - sadly along with your super - as the way many smaller ones are hanging on to what little they have and, in some cases, are growing.

Truth is, they don't have as much to lose but everything to gain.

The big miners such as BHP Billiton and Rio Tinto as well as the banks - together worth well over half the market - have been losing ground for a year. But Breville, which is a fraction of their size, is up more than 25 per cent.

It's one of several potentially big little stocks. Debt free, they are aspiring blue chips, not that that seems to be any recommendation. Indeed, they want to be careful what they wish for.

Little companies that grew too big litter the landscape.

"Companies can grow above their natural growth rate for a while but not forever. If one tries to grow above trend, such as by diversifying, it's headed for a crash," the managing director of Sirius Fund Management, Kieran Kelly, warns.

He could have been talking about the collapse of Hastie, certainly not stocks such as Fleetwood, Ramsay Health Care and InvoCare, which have strong balance sheets and management, and are sticking to their knitting.

"I don't want them to be the biggest," Kelly says.

They're typical of growing stocks with sound balance sheets. Others that small-company fund managers see as potential blue chips include alphabetically:

AMCOM (AMM)

It has a long way to go to be another Telstra, but the share price of Perth-based telco Amcom is growing a lot faster - up 46 per cent over the past year compared with Telstra's 16 per cent. Amcom has its own fibre network in Perth and Adelaide. "They're clever guys, expanding from internet connectivity to cloud computing. Their revenues are locked in long-term contracts," the portfolio manager of Pengana's emerging companies fund, Ed Prendergast, says. It pays a dividend and has almost no debt.

BREVILLE (BRG)

The plastic kettles are long gone as Breville morphs into an upmarket supplier of "products with a plug", as the acting chief executive, Jack Lord, calls them. They're a big hit, especially in the US where not even the strong dollar can stop Breville. On the contrary, it's naturally hedged - production in China, exports to the US - all in US dollars. Neat. In any case its efforts go into award-winning, consumer-friendly designs.

"The US business is just going incredibly strongly," Geoff Wilson, of small stock fund managers Wilson Asset Management, says. Breville lifted its profit 41 per cent to $29 million in the past half year

HANSEN TECHNOLOGIES (HSN)

As a high-dividend paying, debt-free, profitable growing company the only reason this supplier of health billing systems isn't already considered a blue chip is because the market values it at only about $140 million.

It's just won the contract for managing gas and electricity bills for a US company in New York and Pennsylvania. You can't get more blue chip than issuing bills for somebody else.

"Defensive earnings are a good thing at the moment," says the chief executive of Lincoln Indicators', Elio D'Amato, who, incidentally, was warning about Hastie back in 2006.

iiNET (IIN)

Second only to Telstra in supplying ADSL broadband, iiNet's advertisements say "we know what it's like to take on the big boys". It looks like becoming one, too. "It has 1 million customers, mostly in broadband but it also has mobile," the portfolio manager of the Eley Griffiths small companies fund, Brian Eley, says.

"There is a very strong cash flow through subscribers. It's acquiring new customers on its own infrastructure rather than renting from Telstra." It also seems to be NBN-proof. The further NBN goes, the less iiNet needs to spend on infrastructure. Or if NBN stops under a change of government, Eley says iiNet will "keep on going as it is".

REVA MEDICAL (RVA)

Bio-tech stocks rival small miners as toys for speculators, but some have gone on to be blue-chip beauties. Think Cochlear or CSL. Reva is in clinical trials - the bio-tech equivalent of drilling reports - with its heart stent, which is bio dissoluble when no longer needed.

The market is worth $5 billion, with only four players(one of which is a Reva shareholder). "When you bring in a new product you can charge a premium. It's a huge gross margin. Cochlear started in a similar place," the portfolio manager at Naos Asset Management, Sebastian Evans, says.

SWICK MINING (SWK)

This supplier of drills for mining, especially of gold, may never become a blue chip, but only because it's likely to be bought out beforehand, the Perennial Investment Partners' portfolio manager, Grant Oshry, says. "It's trading at a 30 per cent to 40 per cent discount to its peers and there's more risk of it being taken over." He likes it because "it has an owner-operator mentality" - the managing director is the founder who is happy to spend on research and development to get more drill for the dollar.

Plus, you can buy the shares for less than they're worth because the market has moved on from mining-services companies. So "it's off the radar and unloved but has potential in five years," Oshry says.

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