Values get hard to find in small-company stocks

May 10, 1992|By Jonathan Lansner | Jonathan Lansner,Orange County Register

Where have all the small stocks gone?

Small-company stocks long have been the favorite of small investors. The lure of finding the next Apple Computer or MCI before the Wall Street pros latch on to it is tempting.

But investors seeking to use lesser-known companies as the road to wealth today will find fewer and fewer traditional "small cap" stocks, as traders call them.

A rally in companies with more modest market capitalization -- that is, share price multiplied by number of shares, or the value of all stock outstanding -- has turned many small caps into bigger fry or made them expensive by various market measures.

The shortage of high-quality small-company investments is so severe that Fidelity Investment halted sales of its Low-Price Stock Fund because it couldn't find enough good stocks to meet its criteria for small cap companies.

"They've had a tremendous run," fund manager Joel Tillinghast said. "It became hard to put our new money to work."

However, most individual don't have to invest $750 million, as Mr. Tillinghast does. Even he said there still are compelling reasons to own small-company stocks -- after careful selection.

One often-quoted reason is studies that show how these tiny shares have produced the greatest returns. Figures from Chicago-based Ibbotson & Co. show that small stocks have outproduced big stocks since 1926 by an average annual margin of 12 percent to 14 percent.

That edge comes from economics, specialists said. Small companies often have several built-in advantages over larger competitors: They can be more nimble and react faster to changes in their business or the economy. Often, they control or are concentrating on tiny business niches with proprietary products or new technologies.

As several analysts noted, it's a lot easier to double the size of a small company than, say, International Business Machines Corp. General Motors Corp.

"I'm always looking for a company with an edge, something most people wouldn't understand, something that will dramatically change the stock," said money manager Barry Feirstein of Equitable Capital Management in New York.

That small-company advantage has been hard to find on Wall Street in the last decade, however.

Small cap stocks languished and missed much of the 1980s bull market. In that decade, the name of the investment game was finding big companies that would be subject to takeovers or restructurings. But since late 1990, small-company stocks have taken center stage.

The NASDAQ Composite Index, often seen as the gauge of the small-issue market, was up 52 percent in 1991, compared with a gain of 26 percent for the Standard & Poor's 500, the often-quoted benchmark for bigger stocks. That reversed the trend from 1983 to 1990, when the S&P 500 gained more than the NASDAQ, 100 percent to 34 percent. And this year the NASDAQ and the S&P are virtually neck and neck -- both off about 1 percent.

After the 1991 rebound, many small stocks are at lofty prices, money managers say.

"It's more and more difficult to find good investments. The bargains are less and less," Mr. Feirstein said. "A wave like this [small-cap] rally, it may continue. It may become self-fulfilling and get carried away a little."

Experts fear that small investors disgusted with paltry savings yields might be tempted to jump into small-stock investments anyway, particularly after looking at returns that have been astronomical during the past 18 months.

Already this year, those who jumped into smaller biotechnology or other health-related shares have seen losses of 20 percent or more.

The common advice to fledging small-company investors is this: Be ready to tie up your money for years.

"You have to consider your time horizon, because every stretch of time will not be as good as what we've just been through," Fidelity's Mr. Tillinghast said.

The shortage of high-quality stocks isn't the only concern an investor should have with small companies.

These lesser known stocks are rarely watched by big brokerages or institutional investors. That's a plus for getting in early on a good one.

But when few professional investors follow a stock, it typically trades erratically. That volatility alone can scare off many small investors.

Additionally, such unpopularity can mean that good news often gets ignored for long periods because no one with enough investment clout to move these stocks is interested, experts said. Thus, patience is a major requirement for those daring to trying buying small-cap issues.

"The problem with true small caps is that . . . you got to wait until somebody discovers them to make any money," said Mike DiCarlo, a portfolio manager at John Hancock Mutual Funds.

Nevertheless, the hot area of small company investing is in "value" issues -- stocks trading at cheap valuations compared with the overall market or competitors.

In 1992's first quarter, the top 25 performing mutual funds included such value oriented small-cap funds as Heartland Value, No. 3, up 20 percent; Colonial Small Stock, No. 11, up 17 percent; Babson Enterprise, No. 21, up 13.8 percent; and DFA US 9-10 Small Company, No. 23, up 13.6 percent.

Instead of buying small, rapidly growing companies -- or ones with cutting-edge technologies -- a value investor today likely holds many companies trying to recover from economic maladies or companies in less-than-glamorous businesses.

Such profiles meant that in 1991, when the rest of the small company area was hot, these stocks were left behind. That's changed this year.

"You're talking about stocks where no one looks there," Heartland Value co-manager Mr. Denison said. "And when these

stocks move, they move in a hurry."

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