American Capital Management, Inc. |
Academic studies indicate that smaller companies have outperformed the S&P "500" and inflation over the past 50 years, each 25 year subperiod and during most five year periods. Investment strategies designed for superior performance should include quality small and medium sized growth companies.
Investing in smaller growth companies is a key component of investment success among professional investors. This recognition is the result of impressive market performance and outstanding operating growth over the years. We are also experiencing an economic, political and social environment that favors smallness over bigness and investing in smaller growth companies. As a result, a more favorable risk/reward ratio exists for investing in this market segment. This has occurred as smaller companies developed professional management more capable of meeting the challenges of growth. The major considerations supporting the secular trend of investing in this market segment are as follows:
Management - The management teams of smaller companies have become highly professional. As a result, these companies possess sophisticated controls and operations to more effectively plan, direct and control their development. This improved professionalism combined with an entrepreneurial spirit and equity ownership is a highly desirable component of investment success.
Operating Strength - Earnings and dividends have experienced growth 100% greater than the S&P "500" over most five year periods . Also, when earnings for the S&P and the DJIA declined during unfavorable economic periods, smaller growth companies averaged earnings increases of approximately 10%. This is a most impressive performance and proves the underlying fundamental strength inherent in a quality group of smaller companies. Many of these companies also have fully funded pension plans - a major financial advantage over the longer term.
Flexibility - The relatively smaller size of this group limits their exposure to government intervention and regulation and enables management to more effectively develop their growth. Their size also enables management to make timely decisions to capitalize on favorable trends or limit unfavorable developments. This is most helpful in directing and controlling capital expenditures, financial plans, inventories, marketing operations, production, research and development, etc. In addition, growing smaller companies possess relatively modern facilities and less unionization, thereby enhancing their international competitiveness and operational flexibility.
Political Environment - The political environment is gradually favoring smallness over bigness. Government is beginning to recognize that growth incentives are necessary to overcome the problems of economic growth. As a result, smaller companies are becoming increasingly important because of their dominant role in economic growth and employment. For example, this market segment represents over 90% of all corporations, employs the majority of our work force and creates most of our new jobs. Looking ahead, we are likely to experience continued favorable government action to encourage the growth and investment in smaller companies.
Investment Risk - There is less investment risk in smaller growth companies over a market cycle. This is primarily the result of their proven ability to generate significant and consistent growth in revenues and earnings. These quality companies also experience greater acquisition activity thereby enhancing returns to investors. Additionally, the increasing interest in these companies among professional investors is moderating their market volatility and investment risk over the intermediate term. These trends will gradually develop increasing recognition of the favorable risk/reward ratio that exists for investing in this market segment.
Research Coverage - The limited amount of research coverage on these companies has created an inefficient market sector and more attractive investment opportunities. The contraction of the brokerage community over the past two decades has substantially reduced the analyst corps and the industry's ability to properly research these companies. In addition, the profitability pressures in the industry limit coverage of those companies with limited capitalizations. These developments have created an opportunity for investors to achieve "value added" with sound investment judgment.