Dave-
I happen to be a research specialist of small stocks, and I am not going to change my investing habits or recommendations to follow some greater-fool theory herd. I believe wholeheartedly that an individual investor who identifies small companies with improving financials, strong sales and earnings growth, and relatively low valuations will make some serious money, regardless of the overall trend of small-cap investing. I first noticed THQI 2.5 years ago when it traded at $4, and it has run circles around KO and its overpriced brethren. At some point, the overpriced big stocks will be too pricey, and a long period of underperformance will ensue. There may not be any sizeable pullback or bear market, but the small stocks will catch up nicely. Obviously, the weak small stocks won't do well; a rising tide may lift all boats, but the outperformance I'm referring to is akin to an inflated beach ball rising to the surface of the water.
A strong, rapidly-growing company can stay undervalued for only so long. There are 2 major factors that can suddenly cause a small-cap stock to outperform: the market cap can increase until it reaches a size that hits the screens of mid-cap mutual funds; the company can be acquired by overpriced big caps.
For THQI, the first situation may not happen for a year or more, as THQI needs to reach $65-70 to get a market cap of $500 million. The second situation could happen at any time, as soon as THQI gets an offer high enough. If ERTS offered $75 right now (extremely unlikely), I'd bet that Farrell would sell out. And I'd agree. And it would probably enhance ERTS' 1999 EPS. THQI is not for sale, because not company is going to offer a 200% premium over the market price. And anything less would be a low price, IMNSHO.
Declining operating margins? That's a poor reason for underperformance. Obviously, if a company has declining margins, it shouldn't be purchased. That's no mystery. THQI's Q1 operating margin was 20%, thank you. And my estimates call for 17% in 1998 and 20% in 1999. You can't beat that with a (big-cap) bat.
Maybe it IS different this time. So if/when the market stops going up, the money will shift into the undervalued small stocks, and the big caps will have a well-deserved bear market. Besides, most institutional money is in the big stocks, so how much damage could a institutional panic cause? A long, protracted period of market weakness (rather than a sharp correction) is likely to help small caps, relative to big stocks. But a correction causes the fearful institutions to cling to their big-cap (security) blankies.
Thanks for the interesting artice. Remember that the prevailing practice or behavior is not always indicative of the smart thing to do. And in time, the value of a company will come through, and THQI will get the valuation it deserves.
Todd |
