INVESTING

Is the age of mega-companies over?

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Just as the economy works in cycles, so too do companies.

The big question investors should ponder is whether the age of mega-companies is over.

The problem of becoming too big is that it becomes harder and harder to achieve double-digit growth, so shareholder returns eventually fall and profits, dividends and share prices come under pressure.

fairfax media hot stock mega-companies

In the past, an advantage of being part of the Australian economy was that strong population and wages growth would drive the earnings of companies large and small.

Because Australia was a relatively protected island with a small population, there was limited competition for anything: so two major airlines, four big banks, two big supermarket chains, two major department store chains and so on.

But the online world changed the face of competition here, and globalisation means more international companies have been attracted to its wealthy, growing population and an economy where existing players have limited competition.

External and internal factors have combined to affect the returns and share prices of blue-chip companies such as Woolworths, BHP Billiton and the major banks.

Two key external factors are record low wages growth in Australia (and our associated low inflation) and our population growth rate has been easing down since its high in 2009.

Slower population and wages growth, limits companies' ability to raise their prices - as shown by the fact that rental growth on investment housing right now at 20-year lows.

Then there is increased competition. With slow or no sales growth, large companies are highly vulnerable to start-ups whose margins and overheads are lower.

Aldi's apparent easy entry into the local supermarket industry against two highly entrenched players is a classic example.

That it could grab 12% market share on the east coast inside a decade says everything about its competitors' complacency and underestimation of the newcomer's resolve and business plan.

For an investor, the time is right to delve into the smaller end of the market to find those companies disrupting the big end of town and capable of increasing their profits at multiples that big companies can only dream of.

Last year 120 companies listed on the ASX; in 2014 it was 107. But in 10 months of 2015-16, 103 new companies have raised capital and joined the boards ... and there are more coming.

In the online technology era, many new companies have been born without needing costly legacy systems (their multimillion-dollar cost, remember used to prevent the entry of competitors) and with a mindset that they can attack incumbents from the outset.

And this is the key for investors hunting growth stocks in a low-growth era: companies with a small or moderate amount of shareholders' capital but with very big returns.

Think of seek.com, rea-group.com and carsales.com.au. The internet let each of them to compete - with large newspaper companies especially - needing none of the previous capital requirements or costs.

And history tells us this approach works. Each of those companies is now valued by the stockmarket at a significantly greater amount than the companies they usurped (Seek $5.6 billion, REA $7.3 billion, Carsales $3 billion compared with Fairfax Media $2.2 billion).

The share price and dividend growth of these companies is the ultimate proof of the strategy's worth.

The method for identifying these companies is not easy. All companies try to dress themselves up in the very best light so as not to spook their shareholders or staff.

So look at the cash flow statements to see progressive growth in sales. Look at the shareholder capital in the business and consider the ability for the company to grow.

Understand there is risk. Until Lachlan Murdoch turned up with News Corp's cash, the founders of Carsales famously were wondering where they would find a new backer, or if their business would go to the wall.

It really does help to read the prospectus and annual reports. It's even better to attend annual meetings, where you can meet the management team and the board.

That instant appraisal can often help with your line call but do not be tempted by slick presentations alone.

The message here is that to find growth; look for the combination of strong potential cash flows off a very small capital base.

The right choices are the keys to creating significant long-term wealth in a low-growth era.

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