Think tiny for really big returns

SMALL may be beautiful, but for investors, tiny is exquisite. A new study shows that stock market minnows have been the star performers as share prices have started to recover from their lows of last year.

Average share prices on the London Stock Exchange fell until mid-March in 2003, then started a strong recovery. By the end of the year, they showed an average return of 21% over the 12 months. Shares in small companies - the bottom tenth of the market by size - soared 43% over the year.

But the latest ABN Amro/London Business School Global Investment Returns Yearbook, published last week, reveals that smart and brave investors would have chosen not just small companies, but tiny ones.

The MicroCap index, which tracks the smallest 1% of UK quoted companies, showed an astonishing 66% jump in 2003.

The trend cannot always be relied on. In much of the Nineties, shares of big companies did better than small ones, but since 1999 the minnows have reasserted their superiority of returns for investors.

While share prices as a whole have fallen from their peak at the start of the millennium, values of the smallest companies have held up.

Paul Marsh, one of the report's authors, said: 'If you had stuck to the absolute minnows, you would be asking, What bear market?'

Most investors have had a pretty tough time since the market peaked four years ago. Even with last year's bounce, shares fell 22% from 2000 to the end of last year. But investors in the tiny companies showed a cumulative return of 47%.

In the long term, it appears that backing very small companies should reap rich rewards. An investment of £1 in the stock market at the start of 1955 would have grown to £486 by the end of 2003 - equivalent to an annual return of 13.5% - ignoring taxes and dealing costs.

An investment of £1 into the smallest 10% of companies would have increased to £1,513 over the same period, equivalent to a return of 16.1% a year. But the yearbook says: 'An investment in micro companies would have yielded £8,123, equivalent to a return of 20.2%.'

The ABN Amro/LBS study is based on data from the start of the 20th Century. It shows that £100 invested in equities in 1900 would be worth £1.3m by the end of 2003 - assuming no taxes and that all dividends were reinvested in shares.

Inflation over that period means that it takes £59 now to buy what would have cost £1 in 1900. Even so, the purchasing power of an investment in equities has risen 224-fold.

But the vast majority of that gain is achieved only by ploughing dividends back into shares. Share prices alone over the past century have risen just 0.6% a year faster than inflation.