Small company stocks enjoy their best year ever and gain new interest from investors.
Underappreciated for years, small-company stocks finally exploded intoinvestment favor in 1991. Will their newfound preeminence last?
While the country's largest public corporations -- General Motors, IBM, Westinghouse, Woolworth, and the like -- are coming apart at the seams, its smallest have been putting on quite a show of strength. Small-capitalization corporations -- those whose market value is a few hundred-million dollars or less -- enjoyed their best stock-performance year ever.
In 1991 the blue-chip 30 Dow Jones Industrials gained 20%. But the Dow wasn't where the action was. The real movement was in the automated over-the-counter market, NASDAQ, where at the close of the year the average market value of a listing was $126 million, or approximately one two-hundredth of GM's. The NASDAQ Industrial Average soared a monumental 65%. Similarly, the Hambrecht & Quist Growth Index, composed of about 100 companies with market values of less than $200 million, surged an even longer 94%. Trading on NASDAQ soared to 41.3 billion shares (a record), and dollar volume to $694 billion (ditto).
Small-cap stocks' climbing to record heights suggests a fundamental shift in investors' appreciation of our economy's future. Previously chary of the risk inherent in small-cap corporations -- and of in-and-out liquidity problems due to their relatively low number of outstanding shares -- many an institutional trading desk hired a small-cap money manager in 1991.
Why? Not because they suddenly discovered that growth-oriented management was more alert. Or that small companies could adapt to change faster, grab market share faster, create new products faster, bring them to market faster, start selling them faster, cut fat, trim overhead, go lean and mean -- those abilities they already knew about.
What investors realized was that, almost without exception, small-cap operations were bringing the bacon back home. Such companies thrive best where the rest of the globe hasn't yet dared venture. In 1991 small-cap hot spots included regional health care and delivery, biotechnology, software, computer mail order, specialty retail, and telecommunications -- nary a VCR, TV, slab of steel, or side of beef to be found. Save for the silicon-chip business every now and again, no industrial sector populated by small public companies was so desperately inept that the government had to drag a bevy of underinspired and overcompensated executives across the Pacific to bitch about it.
So let Japan have its MITIs and hierarchies. Big money's eager endorsement of small, non-dividend-paying companies in 1991 recognizes that pure capital gain is itself a rewarding concept. Forget the Nifty Fifty. Forget total return. Growth companies that plow income back into operations constitute a far more sensible investment than behemoths that have no better plan for capital than to raise CEO salaries.
Indeed, our entrepreneurial hockey-stick growth curves are the envy of the Japanese, who for half a dozen years have been trying to light the spark of innovative enterprise under their own worrisomely flattening economy.
They've had little success. So little, in fact, that plenty of U.S. small-company executives have been invited to teach them how to sow seeds properly. We may not be selling them any cars or fridges, but our growth-strategy know-how sure is in demand.
And no wonder. Businesspeople here run clever, raised-on-their-own-nickel companies such as -- to name a few mentioned previously in Inc. -- Symantec, up 233% in 1991; Borland International, up 159%; Ben & Jerry's Homemade, up 151%; Paychex, up 89%; and Dell Computer, up 39%.
By contrast, GM and IBM -- which you have not read about in these pages -- lost 16% and 21%, respectively. Not to mention 114,000 jobs. -- Robert A. Mamis
Relative Market Performance
Industrial average 3/1/91 2/28/92 % Change
INC. 100 11.8 18.7 +58%
NASDAQ 510 722 +42%
AMEX 348 416 +20%
DJIA 2,910 3,268 +12%
S&P 439 491 +12%
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THE FALLOUT
Better private-equity markets, more venture capital, increased eagerness among prospectivebig-company partners ? How the stock market's enthusiasm will change your small company's life
At the heart of the bull market for small-capitalization stocks lie forces that will favor small companies in the years ahead and in turn will reshape the economy in their image.
"Every bit of evidence shows that two things are happening. The size of economic units that do productive things are getting smaller. And the number of those units is increasing,' observes Paul Reynolds, a professor of entrepreneurship at Marquette University. These trends are part, he says, of "a fundamental shift in the economic structure, which will not reverse itself in my lifetime.' Large companies such as IBM, to take a prime example, will never again look the way they did in the 1960s and '70s. "If IBM regains its profitability and market share, it's not because it will hire more people, but because it used fewer people and used them smarter,' he predicts.
The increasing importance and numbers of small companies owe to a series of intertwined factors. Together, they exist as portents that are hard to ignore. Here is a look at some of these present causes and future consequences, presaged by the current bull market for small-cap companies.
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Venture Capital
With IPOs again offering lucrative exits, early-stage investment will revive
The hot market for small-cap stocks and, in particular, for initial public offerings signals the gradual return of venture capital to its original mission: the funding of early-stage start-up companies. That is a role U.S. venture capital increasingly abandoned after the collapse of the IPO market in 1984. As aversion to risk grew inversely to the decline in returns, venture capitalists became glorified investment bankers. Innovative young companies, starved for cash, died on the vine -- or sought out more patient and venturesome Japanese investors.
