Ernst & Young LLP Finds Russell 2000(R) Companies Building Momentum with Growth, Performance, M&A and IPOs

NEW YORK, March 10 /PRNewswire/ -- Ernst & Young LLP conducted a deep analysis of business activity among Russell 2000® companies in the second half of 2009, exploring how the group drives growth in this economy. The key sign of growth, the median market cap, increased from $306 million in June to $394 million by year-end. The analysis focused on market cap and other signs of healthy activity – mergers and acquisitions, IPOs and sources of earnings growth – while also noting re-emergent stock market performance since the annual reconstitution of the Russell in June.

"Most commentary focuses on activity among corporate giants, even though the economic engines are innovation and entrepreneurship," said Maria Pinelli, Americas Director, Strategic Growth Markets, Ernst & Young LLP. "Those characteristics are best measured among more nimble, growth-oriented companies in the Russell 2000. To understand the group potential, it's important to examine multiple aspects of business activity."

The maximum market cap jumped from $1.68 billion in June to $5.52 billion, though the minimum market cap dipped lower. Stock market performance for the Russell 2000 Index reflected that strength – up 25% in 2009 after its plunge of 34% in 2008 – and outperformed the S&P 500 and Dow Jones Industrial Average.

"Last June's reconstitution represented a low-water mark to be included in the Index, allowing smaller companies the visibility and opportunity associated with investor interest in major indices," said Pinelli. "The current numbers suggest that all boats are rising with the Russell tide – or at least a significant number of them. But if you are one of the smaller companies, it's clearly time to get growing."

In addition to market cap increases, the group lost 39 companies due to mergers and acquisitions since the June reconstitution – more than double the 19 similar transactions in the first half of the year. The pace of these deals gradually increased during the year, with 25 deals occurring in Q4 2009.  While those companies have disappeared from the Russell 2000 list, their activity represents the return of business investment.

IPO activity also grew in the second half of 2009. Thirty-two IPO entrants were added to the Russell 2000, compared with just 13 in the first six months. Russell adds new qualifying companies from IPOs each quarter. Conversely, Russell also adjusts for delisted companies due to bankruptcies or companies taken private. In that case, Q3 and Q4 2009 saw only three companies delisted.

Year-over-year activity showed some slow-down of M&A activity, but stronger numbers for IPOs and delistings:

Market Cap by Industry

Using market cap as the key measure of growth, the Consumer Discretionary, Information Technology and Materials sectors gained the most. Though Consumer Discretionary companies had the most outperformers – defined as companies with at least 50% market cap growth – Information Technology had the largest proportion of outperformers. Half of the 341 technology companies in the Russell 2000 met the criteria.  

Other characteristics of outperformers included:

• Comparatively large annual sales – though decreased year-over-year sales
• Earnings growth in Q4 driven by cost control
• Highly leveraged with a 51% median debt-to-equity ratio, compared to 37% for underperformers

"Across all sectors, earnings growth was generated by careful management of expenses," said Pinelli. "At some point, companies that expect to grow need to invest and innovate or they won't be able to compete in the global economy. Russell 2000 companies, in particular, are poised to refocus quickly on the next big idea."

Technology Leads Growth

In addition to market cap outperformance, other factors show information technology leadership. Though technology companies represented only 17% of the overall index, almost half (44%) of all deletions from the Russell 2000 due to mergers and acquisitions were in this sector. Within the technology population, 28% have completed an acquisition in the last six months, compared to 18% of companies across the index. Also, the sector holds the lowest level of debt as a percent of equity.

"Tech is where innovation and efficiency live," says Pinelli, "and companies that want to grow are willing to buy it if they don't have it. An investment in technology might represent interest in a new product, but it also might imply a long-term reduction in operating expenses, which continues to be a way to drive income in this economy."

Technology also showed a strong increase in share price (52%) surpassed only by consumer discretionary stocks (60%).

The Financials Story

Financial companies represented the largest percent of underperformers, showing a decrease in market cap.  Financials also had only 5% of the M&A activity though they represent 23% of the entire index. But the group demonstrated strong IPO activity, with 34% of all IPOs that entered the Russell; comparatively, only 6% of consumer discretionary companies and 14% of the overall index had IPO activity.  Financials also represented six of the top 10 companies with percentage increases in net income, though share price decreased by 2%.

"It's important to remember that the financial industry isn't only made up of global conglomerates," said Pinelli.  "It's feast or famine according to size, credit stability and lending ability. The regional banks and other smaller institutions represent a significant part of the industry, and can provide great insight on the economy overall."

Regarding net income, she noted, "Companies pare down expenses and clean up their balance sheet as they prepare to go public. The increases in net income make absolute sense among a group that is showing strong IPO activity."  

All 2,009 companies (2000 adjusted for IPO entrants, delisted and acquired companies) that were included in the 2009 Russell 2000 Index as of December 31, 2009 were part of this analysis.

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SOURCE Ernst & Young LLP