The Financial Reporting Council (FRC), which sets UK accounting standards as well as the corporate governance and stewardship codes, has since October 2014 been asking these questions of fund managers who specialise in very small listed companies - those on the main market with capitalisations of between £20m and £100m, and those listed on the Alternative Investment Market (Aim) with a capitalisation above £5m. The conclusion is hardly a shocker: investors do indeed attach a lot of importance to annual reports, and there is room for improvement in the quality of reporting.
The real shocker is that company management teams are wont to believe the opposite. "Many smaller quoted companies think that investors do not read their annual reports and therefore that the reports are of little value. As a result, the preparation of the annual report becomes a compliance exercise rather than being seen as an opportunity to provide relevant information to stakeholders," notes the FRC in its discussion paper.
This account reminds me of Mountview Estates (MTVW), an off-the-radar property company that owns a portfolio of London homes subject to pre-1989 regulated tenancies. Its updates to the market are the embodiment of reporting as a compliance exercise, containing virtually no information. Unlike the vast majority of smaller companies, its management team - which is dominated by members of the founding Sinclair family - never speaks to Investors Chronicle, nor to anyone else in the media or the City. The Sinclairs, who through a so-called 'concert party' agreement own the majority of the shares, effectively run the company as if it were private.
Mountview is interesting because its shares have performed extraordinarily well, having more than doubled since I tipped them (Buy, 5,150p, 4 Apr 2013). That's partly because the company operates in a strong market - London property. But it's also because management has come under pressure from some family members (or possibly minority shareholders - it's impossible to tell precisely) to open up. That led first to the splitting of the chairman and chief executive roles in 2013, then - crucially - to a revaluation of the company's trading property portfolio last November. This showed it to be worth £666m, compared with a book value of £318m. The shares have rocketed since, even as the London housing market has cooled.
This is a rather unusual example - more often the problem is reconciling a management team's sales pitch with the financials - but it does make a couple of useful points. For a start, the only documents Mountview puts any effort into are its annual reports. Without the audited statutory information these contain - notably the difference between the book value of its properties and their eventual sales value, which alerted me to the massive undervaluation of the portfolio - I would never have been able to make a buy case for the shares. In short, annual reports are a vital resource for investment research, particularly for companies with no or very limited analyst coverage.
The second point is that improving governance and transparency has the capacity to drive returns. If the FRC's campaign to raise standards is successful, it might - just might - boost the woeful performance of Aim.
So how can reports be improved? One problem the FRC identifies is "boilerplate disclosure" - in other words, copying passages from standard reporting models rather than expressing a company's individual circumstances. The result is that reports can be both voluminous and lacking in information. Another weakness is that business reviews for microcaps are "not always balanced or comprehensive, or appear to be inconsistent with other information". For example, it is not always clear whether growth is organic or acquired, and the analysis of exceptional items is often "inadequate".
As I explained in a cover feature last year ('Financials in Focus', 31 Oct 2014), such grumbles are all too familiar to writers at Investors Chronicle. Our consolation is that we can usually speak to management to fill in the gaps or explain the contradictions. Private investors don't have that privilege, so are completely reliant on solid financial reporting. The FRC is holding an open meeting on this subject on 9 July and soliciting feedback on its findings until 31 July. Those private investors who are interested in micro-cap stocks would do well to make their voice heard.
