Last week saw another accounting scandal at one of Britain’s iconic companies. BT shares fell 21 per cent after the revelation of serious misrepresentation at its Italian unit. This shock follows the Tesco debacle of a couple of years ago, which inflated profits by around £300 million and is still winding its way through the courts.
Smaller cap stocks are regarded as riskier than blue chips, but these examples show that the titans of the FTSE 100 can hit investors with nasty surprises too. Pearson has also plummeted by 24 per cent this year as its business strategy has unravelled and we have had the revelations of systemic corruption at Rolls Royce. Big caps might benefit from being more broadly based and financially more powerful than small caps, but that brings its own challenge of complexity.
Impressive-looking boards of directors and are no guarantee that big caps will be well run. Even top-notch corporate governance practices can be undermined by the huge scale and complicated nature of big FTSE 100 stocks.
I’ve always thought the description of small caps as ‘riskier’ is a bit lazy. It’s might be fair comment at the very small micro-cap end of the market. But there are plenty of really good quality small caps in the £100 million plus market cap band which are well financed, well run, and are relatively easy to understand. That last point is crucial if we want to avoid surprises.