The latest available economic data indicate that the Irish economy continues to grow rapidly and that the long-expected slowdown has yet to materialise. Despite this buoyant economic growth, the Irish equity market has under-performed global equity markets and the booming domestic property market over the past two years. Last year the Irish market suffered from portfolio rebalancing by domestic institutions and the sharp declines in the share prices of the banks.

Fears that the economy would overshoot and, more latterly, a perception that banks are ill-prepared to cope with the threat from Internet banking, seem to have been the major factors underlying this share price weakness.

Although global themes will continue to exert a major influence on Irish share prices, the buoyancy of the domestic economy is leading to strong growth in the corporate profits of the Irish quoted sector. In particular, this has been the case for many small and mid-capitalisation stocks that tend to be more heavily dependent on the domestic economy compared with their largecapitalisation counterparts.

This is being reflected in generally very strong corporate results. The recent financial results statement from DCC (market cap: €950 million) is symptomatic of just how well the core businesses of many second-line companies are performing. DCC reported profits of €139.2 million for the year to March 31st, up from €57.7 million the previous year. These results include an exceptional gain of €71.3 million from the well-timed sale of the group's shareholding in Fyffes.

Nevertheless, underlying pretax profits increased by a strong 20 per cent and the confidence of the group in its future prospects was reflected in the 20 per cent increase in the dividend.

Another mid-capitalisation company that continues to advance strongly is Grafton Group. It recently announced a bolt-on acquisition in the UK of Essex Heating Supplies, a regional plumber's merchant. Grafton has expanded rapidly in recent years through a combination of organic growth and timely acquisitions allowing it to produce consistently good financial results.

Since 1987 the company has achieved a compound annual growth in its earnings per share of 29 per cent. Despite this the shares are trading on a lowly price-earnings ratio of 8.7 for 2000. Even compared with the relatively low ratings afforded builders merchants across Europe (see table), the Grafton rating still seems to seriously undervalue the business.

For example, Travis Perkins in the UK trades on a p/e of 9.8, while Hornbach Holdings in Germany trades on p/e of 12.

The main cause of the relative undervaluation of many of these smaller companies continues to be the lack of institutional demand for smaller companies. There seems to be little sign that this negative sentiment is about to turnaround and therefore an across-the-board rise in the share prices of these companies still seems to be a distant prospect.

However, as long as the underlying businesses continue to perform well, ultimately share prices will have to reflect the underlying strong financial performance of the majority of these small and mid-capitalisation companies. Therefore, in the current volatile investment climate some selective investment in undervalued Irish smaller companies could result in some very good longterm returns.