HEROES
ROMAC INTERNATIONAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ROMC)") else Response.Write("(NASDAQ: ROMC)") end if %> continued its year-long run today, adding another $2 1/2 to finish at $27 1/2 after the temporary-staffing firm came in with estimate-busting earnings on Tuesday. Per-share earnings grew by 75% on revenue growth of 118%, while sequential growth (from last quarter) surpassed 25% per share. Like other small- and mid-cap staffing companies, such as ACCUSTAFF <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ASTF)") else Response.Write("(NASDAQ: ASTF)") end if %> or ON ASSIGNMENT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ASGN)") else Response.Write("(NASDAQ: ASGN)") end if %>, these shares can be driven up by expectant growth capital trolling for the best return. However, if a company hits its objectives in making the right kinds of acquisitions and expanding markets, such as Romac has been doing, then increases in shareholder value will often result. In the pursuit of these goals, it probably wouldn't be surprising to see a company like Romac offer staffing for volatile industries such as PC board manufacturers or semiconductor manufacturing.
Paper towel and tissue manufacturer JAMES RIVER CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JR)") else Response.Write("(NYSE: JR)") end if %> rolled its way up $3 1/2 to close at $31 5/8 today after launching a surprise earnings attack on the market today. The company's brands include such name as Dixie Cups, Vanity Fair, and Brawny. Though the company's results were down from last year, EPS of $0.48 per share trounced analysts' estimates. The company's earnings are hard to gauge at first blush, due to its spin-off of CROWN VANTAGE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CVAN)") else Response.Write("(NASDAQ: CVAN)") end if %> last year. After jettisoning some debt with Crown, James River is now free to focus on products that are branded. Rather than competing along all fronts with larger companies such as INTERNATIONAL PAPER <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %> or CHAMPION <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CHA)") else Response.Write("(NYSE: CHA)") end if %>, James River has chosen the more defensible positions in its portfolio, which include its investment in Europe's # 3 paper company, Jamont. Compared with last year, the strategy is working, as cash flow through the first nine months of 1996 have grown 30%, partly due to lower pulp costs, but also due to good expense management.
VERSANT OBJECT TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: VSNT)") else Response.Write("(NASDAQ: VSNT)") end if %> rocketed ahead $5 5/8 to $24 after snuffing third-quarter estimates of $0.03 EPS. The object database management system developer reported earnings of $0.07 EPS, leaps and bounds ahead of the $0.09 EPS pro-forma loss in the year ago period. This performance came in spite of the fact that Versant did not recognize revenues from one of its main customers because of a project reevaluation, although the company believes that these revenues will indeed eventually be recognized. Versant sports a blue-chip list of customers, a nice Web site (www.versant.com), $0.10 EPS in trailing earnings, $10 million in trailing revenues, $15 million in cash, and a market cap of around $212 million. One of its main competitors is OBJECT DESIGN <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ODIS)") else Response.Write("(NASDAQ: ODIS)") end if %>, up $1 1/2 to $11 3/4 today.
QUICK TAKES: Swedish company TOOLEX-ALPHA NV <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TLXAF)") else Response.Write("(NASDAQ: TLXAF)") end if %> moved up $1 1/4 to $10 1/8 on news that this maker of capital equipment for the optical storage industry will set up a service center in North America... MAFCO CONSOLIDATED <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MFO)") else Response.Write("(NYSE: MFO)") end if %> rose $1 7/8 to $26 1/2, having made a deal to sell its licorice-flavoring division to POWER CONTROL TECHNOLOGY <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ATP)") else Response.Write("(NYSE: ATP)") end if %> and focus on its landing gear and flight systems business... Communications equipment maker ACT NETWORKS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ANET)") else Response.Write("(NASDAQ: ANET)") end if %> moved up $2 1/2 to $29 1/2 after Hambrecht & Quist upgraded the maker of networking equipment to a "strong buy."... WISCONSIN CENTRAL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: WCLX)") else Response.Write("(NASDAQ: WCLX)") end if %> chugged ahead $3 1/8 to $39 3/8 upon announcing that it will purchase 220 route miles of trackage in Great Lakes states from UNION PACIFIC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UNP)") else Response.Write("(NYSE: UNP)") end if %> railroad... HYPERION SOFTWARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: HYSW)") else Response.Write("(NASDAQ: HYSW)") end if %> reported flattish numbers, but jumped $3 1/2 to $19 3/8 as the company is climbing its way out of the cellar after stumbling on sales numbers in April... Across the pond, PHILIPS ELECTRONICS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PHG)") else Response.Write("(NYSE: PHG)") end if %> reported sharply lower earnings but rose $2 1/8 to $35 1/8 as investors formulate estimates for what a slimmed-down Philips will look like.
GOATS
The stock price of ASYST TECHNOLOGIES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ASYT)") else Response.Write("(NASDAQ: ASYT)") end if %> did a pretty good impression of chip prices today, as the shares fell $3 1/2 to $17. Earnings fell short at the company, which makes plant automation equipment for the semiconductor industry (one print campaign depicts a hung-over fab worker dropping a cassette of silicon wafers, suggesting that companies should automate), despite its reporting a 45% increase in revenues. Analysts at research group Infrastructure said after listening to the conference call that Asyst experienced order delays of $19 million late in the quarter, which caused the $0.47 reported EPS to fall $0.30 short of estimates. The company also said last night that orders will flatten over the next couple of quarters as much of the semiconductor industry is finding it hard to commit to new projects.
Financial processing company CHECKFREE CORPORATION <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CKFR)") else Response.Write("(NASDAQ: CKFR)") end if %> fell $3 1/2 to $17 3/8 after reporting increased pre-tax losses for its first quarter. Though revenues advanced 165% and contracts expanded as the company strives to create strengths in transaction processing, its returns on assets and equity are going in the wrong direction. Even though consumers recognize the name through its association with INTUIT <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: INTU)") else Response.Write("(NASDAQ: INTU)") end if %>, some might ask where one can find Checkfree's "moat" -- its differentiating characteristics. "Online" isn't new in financial processing, as companies have been doing that for decades on their own secure networks. Companies such as FIRST DATA CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FDC)") else Response.Write("(NYSE: FDC)") end if %> and former General Motors unit EDS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EDS)") else Response.Write("(NYSE: EDS)") end if %> rule the world here. Finally, in software development, these companies have much larger resources to develop the front, middle, and back ends of the software package in order to win and work with customers.
MULTIPLE ZONES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MZON)") else Response.Write("(NASDAQ: MZON)") end if %> got smacked for $5 5/8 to $20 1/4 this afternoon after the catalog direct-mailer of personal computer-related products reported its third quarter earnings. Even though the $0.24 EPS results were in line with expectations, they were flat versus last quarter and ended a nice series of sequential increases. Sales increased 86% while earnings growth was muffled by 30%-plus additional shares outstanding. The shares now have a 0.95 price/sales ratio, but a PEG of 0.41 on current 1997 estimates of $1.50 EPS, trading with a P/E of 24. This compares favorably with competitors like CDW COMPUTER SYSTEMS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CDWC)") else Response.Write("(NASDAQ: CDWC)") end if %> and GLOBAL DIRECTMAIL <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GML)") else Response.Write("(NYSE: GML)") end if %>, although once-highflying MICRO WAREHOUSE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MWHS)") else Response.Write("(NASDAQ: MWHS)") end if %> is a relative bargain. Call-center manager ICT GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ICTG)") else Response.Write("(NASDAQ: ICTG)") end if %>, another summer initial public offering, was also down, off $3 7/8 to $6 1/8.
QUICK CUTS: ACCENT SOFTWARE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ACNTF)") else Response.Write("(NASDAQ: ACNTF)") end if %> tumbled $3 1/4 to $8 1/2, pre-announcing nearly $6 million in losses for the September quarter... Specialty chemical maker HERCULES <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HPC)") else Response.Write("(NYSE: HPC)") end if %> dropped $3 7/8 to $46 1/2, slightly missing estimates while the company recorded an 11% increase in earnings per share and a 33% annualized return on equity. Some investors may fear that higher oil prices and reduced pricing power will hurt the company, both factors having helped over the last three years... ARKANSAS BEST CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ABFS)") else Response.Write("(NASDAQ: ABFS)") end if %> dropped $1 1/4 to $5 1/8 as trucking operations kept the company back from distributing dividends and getting the financials back on track.
MORE QUICK CUTS: TSX CORP. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TSXX)") else Response.Write("(NASDAQ: TSXX)") end if %> lost $2 3/8 to close at $9 1/2, as the communications equipment maker announced that its largest customer -- without too much doubt, TCI COMMUNICATIONS <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: TCOMA)") else Response.Write("(NASDAQ: TCOMA)") end if %> -- suspended orders for the quarter. Today's revelations on TCI might explain some of GENERAL INSTRUMENT CORPORATION'S <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GIC)") else Response.Write("(NYSE: GIC)") end if %> recent decline... APOLLO GROUP <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: APOL)") else Response.Write("(NASDAQ: APOL)") end if %>, the large private-education company, dropped $2 7/8 to $27 1/4, even though the company reported a 50% increase in fourth quarter earnings on Monday... VESTA INSURANCE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: VTA)") else Response.Write("(NYSE: VTA)") end if %> dropped $1 5/8 to $27 5/8 as third quarter earnings came in below estimates... Electronics connector company AMP INC. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AMP)") else Response.Write("(NYSE: AMP)") end if %> dropped $2 1/2 to $35, reporting unspectacular earnings due to rolling corrections in the PC and networking businesses.
FOOL ON THE HILL
An Investment Opinion by MF Templar
Small Company Stocks
Part 3 of 3
I. MISPRICED BECAUSE OF LIQUIDITY
Some will perceive my two-pronged argument that small-company stocks are on average riskier and overall do not outperform large-company stocks as a total indictment of small-company investing. This is not at all the case. Rather, it is an indictment of the ill-conceived blanket statements that the financial industry and the financial press like to make about investing in small companies as a guaranteed way to grow your savings into a mighty oak. Statistically, there are no grounds to say this -- or to say, conversely, that it is actually a way to diminish your savings into insignificance. To make a case for investing in small-company stocks as a class, you must understand why some companies within that class can get mispriced or have the wrong odds placed on them, consequently opening up the opportunity for above-market returns.
What is the upside in small companies? Small companies are more volatile and more inefficiently priced because of something called "liquidity." Liquidity is an investment term that is used to describe the ease with which a given investment can be converted to cash. Different investments have varying degrees of liquidity attributed to them. The high-ticket price and great shifts in demand in the real estate market make real estate a fairly illiquid investment. Contrast this with cash in your bank account -- the most liquid form of savings possible, as it would take only a deposit slip to convert it into cash in your hot little hands. The main factors that drive liquidity include the asset class, the size of the market for that asset class, supply-and-demand dynamics of that asset class, and its utility to the owners. Stocks are considered a pretty liquid type of investment as there is a huge market of daily buyers and you know the going market price at any given time. Within that market, however, some types of stocks are more liquid than others.
The reason why small-company stocks can be mispriced by the market and promise huge returns is because they are normally less liquid than their medium- and larger-company brethren. Massive institutions and pension funds simply cannot buy a reasonable amount of the stock of most small companies to make a difference in their overall return. This happens partially because of the SEC's disclosure cap, which requires that any entity that owns more than 5% of a company be forced to report their holdings and changes in those holdings to the public in a timely fashion. Also, many companies have internal caps on the amount of one firm they can own as well. An example is FMR Inc., Fidelity's parent company, which can only own 12% of a company in all of its funds together. When you own a large slug of a company's stock, it becomes difficult to sell out of it without affecting the price. If major bad news happens, it might in fact become impossible to find enough buyers for the stock, leaving the investment firm stuck with the whole amount. This is why medium- and large-cap stocks are more liquid. Although some small-company stocks become medium- and large-capitalization stocks because the market prizes them so, more often than not small-company stocks are also small-cap stocks -- meaning that the big money cannot own them and their stock is potentially mispriced.
II. WHY INVEST IN A SMALL-COMPANY STOCK?
Because small-company stocks are eschewed by investment firms, pension funds and mutual funds, as well as by the large community of analysts that live off of the fees and services of such funds, they can be really mispriced by the market. In spite of the fact that these small companies can be turning out superior growth and earnings results, their valuations can stay very low because for some reason the stock has not attracted the attention of Wall Street. The optimal scenario for success in investing in a small company is to find one on the verge of becoming a medium or large company in a reasonable period of time and to get in early, before everyone else notices.
A small company sees its valuation driven by becoming a big company. A benchmark that I use a lot when evaluating small companies is to ask how long it will take at the current revenue growth rate to hit at least half a billion dollars in sales, the verge of medium company-dom. By using such a guideline, you focus on companies that are growing sales at a rate to hit at least $500 million within the time period you anticipate making money, normally three to ten years for the Foolish small-company investor. Sure, doubles within six months are great, but as always, you want to avoid swinging for the fences and taking on too much risk. Simply planning on smashing the average 10% return on the S&P 500 is normally more than sufficient.
The reason why I focus on revenues is that while price/earnings ratios have a tendency to fluctuate quite a bit, price/sales ratios tend to be less volatile and a little easier to make conservative predictions about. If a small company is growing at a decent rate and is fast heading toward becoming a medium company, a price/sales ratio of 1.0 is not an unreasonable expectation. This means that at $500 million in sales, you will see a company with a $500 million market capitalization and you will see analysts initiating coverage, investment rags talking the stock up, and funds buying like it is going out of style. And you will have happily been holding on since the sales were $100 million or $200 million, meaning that you may have made as much as five times your money in three to ten years -- not bad.
Here are the average annual sales growth rates needed to grow to $500 million in revenues from various starting points over various periods:
Three Years Five Years Ten Years
$50 million 113.7% 58.4% 26.9%
$100 million 70.1% 40.0% 17.5%
$150 million 48.8% 27.2% 12.8%
$200 million 35.3% 20.1% 9.6%
$250 million 25.7% 14.9% 7.2%
You read it like this: ___ million in sales grows to $500 million in sales in ___ years at an average annual growth rate of ___ .
So, the $50 million, three years, 113.7% looks like:
$50 million in sales grows to $500 million in sales in three years at an average annual growth rate of 113.7%.
Because the rate of growth in sales, earnings and market value tend to converge over time, people who can find solid, truly mispriced small companies early on are rewarded for their persistence and patience over long periods of time. Statistically speaking, you will take on more risk with a small operation, as a fast-growing firm runs into quite a few problems, but this risk can be mollified by simply owning six to ten names. In batches of this size, you will find that you have one or two disasters, one or two huge winners and the remainder simply tread water.
III. WHERE DO YOU FIND SMALL COMPANIES?
The best place to find small companies remains the Peter Lynch way -- look around your daily life and you will inevitably notice something before the rest of Wall Street does. Many people take this as an admonition to "buy what they like," but it is nothing like that at all. Rather, it means that you as a consumer are much more attuned to new and fast-growing phenomena than the average portfolio manager who is poring over 10-Ks and 10-Qs eighteen hours a day. You tend to find things long before Wall Street discovers the fad and starts having eighteen initial public offerings a day with companies currently in the hot sector. You also tend to find things that might currently lack sex appeal, but which, with continued strong growth, could some day demand the investment attention that they deserve.
Another great thinker on the small-company front is Ken Fisher, who articulated the "small companies, small markets, big companies, big markets" premise in 1984's Super Stocks. This essentially means that small and fast-growing markets are the best places to find small and fast-growing companies that can sustain their growth. Rather than looking for the small company attacking the big market, as discussed in "Controlling Risk in Small Companies," you want to find the small company out in front in the fast-growing market. Many people ignore these companies because of the conventional wisdom that some big company will come in and take over. Despite the fact that big companies succeed more than the odds would suggest, the threat of some big company entering into a new market and crushing a small company is always overrated. Folger's did not stop Starbucks. Kentucky Fried Chicken did not stop Boston Market. Cisco did not stop FORE Systems. IBM did not stop Microsoft. And so on. In fact, small companies in small markets need to worry about smaller companies surpassing them, not bigger companies squashing them.
In the end, it is best to offer examples of the small companies I am talking about. Recently, Market Guide gave someone here at Fool HQ their screening software and I took the opportunity to run through it for small companies growing fast enough to become big companies within a few years. In order to find companies that will reach $500 million in sales in three years, I looked at my chart for companies with between $125 million and $175 million in revenues and with compound annual sales growth rates over the past three years of 50% or more. Out of the 68 names that popped out, I present a list of random highlights that should serve as good examples of the kinds of small companies I am talking about.
ACT
MANUFACTURING
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: ACTM)") else Response.Write("(NASDAQ: ACTM)") end if %>
APAC
TELESERVICES
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: APAC)") else Response.Write("(NASDAQ: APAC)") end if %>
CAMBRIDGE
TECHNOLOGY
PARTNERS
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CATP)") else Response.Write("(NASDAQ: CATP)") end if %>
CASINO
MAGIC
CORP.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CMAG)") else Response.Write("(NASDAQ: CMAG)") end if %>
CIBER
INC.
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CIBR)") else Response.Write("(NASDAQ: CIBR)") end if %>
COMVERSE
TECHNOLOGY
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: CMVT)") else Response.Write("(NASDAQ: CMVT)") end if %>
DATA
SYSTEMS &
SOFTWARE
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: DSSI)") else Response.Write("(NASDAQ: DSSI)") end if %>
DREW
INDUSTRIES
<% if gsSubBrand = "aolsnapshot" then Response.Write("(AMEX: DW)") else Response.Write("(AMEX: DW)") end if %>
EAGLE USA
AIRFREIGHT
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: EUSA)") else Response.Write("(NASDAQ: EUSA)") end if %>
HCC
INSURANCE
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HCC)") else Response.Write("(NYSE: HCC)") end if %>
HORIZON
GROUP
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HGI)") else Response.Write("(NYSE: HGI)") end if %>
INSIGNIA
FINANCIAL
GROUP
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IFS)") else Response.Write("(NYSE: IFS)") end if %>
LANDRY'S
SEAFOOD
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: LDRY)") else Response.Write("(NASDAQ: LDRY)") end if %>
MCAFEE
SOFTWARE
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: MCAF)") else Response.Write("(NASDAQ: MCAF)") end if %>
NUMBER
NINE
VISUAL
TECHNOLOGY
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: NINE)") else Response.Write("(NASDAQ: NINE)") end if %>
RISCORP
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: RISC)") else Response.Write("(NASDAQ: RISC)") end if %>
STB
SYSTEMS
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: STBI)") else Response.Write("(NASDAQ: STBI)") end if %>
STRATEGIC
DISTRIBUTION
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: STRD)") else Response.Write("(NASDAQ: STRD)") end if %>
THOMPSON
PBE <% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: THOM)") else Response.Write("(NASDAQ: THOM)") end if %>
VETERNARY
CENTERS OF
AMERICA
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NASDAQ: VCAI)") else Response.Write("(NASDAQ: VCAI)") end if %>
WELLSFORD
RESIDENTIAL
<% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WRP)") else Response.Write("(NYSE: WRP)") end if %>
MF Templar's "Small Company Stocks", Parts 1 & 2
Dale Wettlaufer (MF Raleigh),
a Fool
Heroes & Goats