Small stocks, big potential

Andrew Leckey

January 28, 1992|By Andrew Leckey

Now, let's have an encore. Small capitalization stocks turned in an inspired performance last year, their rise of 46 percent as a group easily overshadowing the stocks of bigger companies.

The question is whether there's still more where that came from. It's true that small cap stocks traditionally do best in periods of low interest rates, when the nation is coming out of recession and in election years. But back-to-back years at that lofty performance level are difficult to predict with any certainty.

"Small cap stocks should continue to outperform larger cap stocks in 1992, for I believe we began a five- to seven-year positive cycle in November of 1990," said Claudia Mott, director of Small Capitalization Stock Research for Prudential Securities. "Investors are becoming more comfortable buying stocks at these lower prices, since not many of them want or can afford to pay for a high-priced stock, no matter how blue chip it is."

Her favorite group is financial services because small banks have performed well and don't have write-offs of bigger institutions. She also likes technology because price levels are currently quite attractive.

Meanwhile, she has cooled a bit on the health care group because its earnings momentum has slowed, with any snippet of bad news capable of driving down prices. Capital-spending firms in heavy machinery and industrial equipment are too economic-sensitive, while utilities are too defensive at a time when the market looks strong.

"Small cap stocks can continue to perform well so long as interest rates stay at current levels," said Alan Radlo, portfolio manager of the $1 billion-asset Fidelity OTC Portfolio Fund, up 49 percent in 1991. "There's a shift on among major pension fund consultants to putting more of their assets in small cap/higher growth stocks, and this, coupled with the growth of small cap mutual funds, helps drive up stock prices."

He has 25 percent of the fund in biotech and hospital companies and 18 percent in banking. He also likes regional airlines, short-line railroad companies and specialty retailers with defined market niches.

The best-performing stocks for Fidelity OTC Portfolio have been United HealthCare, a health maintenance organization that offers popular health plans; Immune Response Corp., which researches and develops pharmaceutical immune systems; SciMed Life Systems, which works in angioplasty; and Parametric Technology, which mechanically designs software products.

Among retailers in the warehouse and warehouse club industry, Radlo is high on stock of Value City Department Stores and Costco Wholesale. Mesa Airlines, a southwest commuter airline, and Heartland Express, an Iowa-based trucking firm, are other favorites. In the financial sector, he likes Wilmington Trust Corp. and Bancorp Hawaii.

"Small cap stocks typically outperform the larger cap stocks for three to four years before large cap stocks regain their strength, so I believe we can look forward to another two to three years of solid returns," said Gus Sauter, portfolio manager of the $142 million-asset Vanguard Small Capitalization Stock Fund. "Momentum is better now because the end of recession is in sight, and it's easier and faster for them to move out of recession because of their small size."

His fund is 15 percent technology, 13 percent health care, 16 percent consumer discretionary products and 19 percent financial services, the rest in various other industries.

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