The Wall Street Journal Interactive Edition -- September 16, 1998
Many Mid-Cap Stocks
Are Now Small-Caps
By AARON LUCCHETTI
Staff Reporter of THE WALL STREET JOURNAL
SAN FRANCISCO -- Meet the small stocks that wish they weren't.
Many stocks that early this year were considered large stocks, or at worst
"mid-caps," have been beaten up so much by investors amid a roiling stock
market that they're officially "small" now. But some could be good buys if
you're patient.
"There are a lot of cheap stocks with strong fundamentals now that have
been shunned by investors who favor large caps and index funds," says John
Skeen, director of research at NationsBanc Montgomery Securities. Many
of the stocks that Mr. Skeen recommends, in fact, are small caps that only a
few months ago were large ones. "These are the ones we've been
recommending," he notes. "They're on the bargain counter."
Over the course of this tumultuous
year hundreds of companies that
started the year with market
capitalizations of $1 billion or more --
or above the level of what is
generally accepted as the definition of
a small stock -- have seen their share
prices pummeled well below that
point. At the same time, thousands of
small stocks have become even
smaller stocks in the bear market that
has afflicted such market measures
as the Russell 2000 index, comprised
mostly of small-cap stocks. Tuesday
the Russell 2000 eked out the
smallest possible gain, a bare one
hundredth of a point, to 357.73. For
the year the index is down 18%, and
since its April high of 491.41, the Russell has slid 27%.
Data presented at this week's NationsBanc Montgomery Securities' annual
investment conference here illustrate the extent to which small stocks have
been discarded in a volatile, nervous market. While the 10 largest stocks
traded on the Nasdaq Stock Market -- all large-cap stocks -- are valued at a
lofty price/earnings ratio of 40, the rest of the companies on Nasdaq have a
P/E ratio of just 17, says Thomas Weisel, chairman and chief executive
officer at Montgomery. Ditto the Standard & Poor's 500-stock index, where
the 50 largest stocks sell at a P/E ratio of 27, while the remaining companies
trade at a multiple of 18 times earnings.
It is that disparity that creates long-term opportunities for some investors,
argues Michael Carmen, a portfolio manager at Kobrick-Cendant Funds.
Last year, Mr. Carmen sold shares of Papa John's International, a Louisville,
Ky., pizza chain, because they had grown too expensive.
Earlier this summer, he began buying back shares as they were falling more
than 30% from their 52-week high. Like many other growth stocks of the
past few years, Papa John's had become a small-cap stock again after a
brutal sell-off.
"It's an extremely well-run company that has executed on its numbers," Mr.
Carmen says. "They tweaked down [future] growth projections a little bit,
and the stock got destroyed."
Explaining what they argue are unjustified collapses in their stocks has been
a major theme among companies attending this year's Montgomery
conference. "This is a very underpriced stock and a very underpriced
segment," Sandy Miller, chairman and CEO at Budget Group told
conference attendees. The Daytona Beach, Fla., truck and car-rental
concern, after peaking this spring near $1.1 billion dollars in market cap
(basic shares outstanding times share price), was slashed by more than 30%
to $717 million, a company spokeswoman said.
Many companies in both the Russell
2000, which is heavy in financial
services, and the Nasdaq composite,
heavy in technology issues, have
fallen back into small-cap land.
According to Frank Russell Co.,
Tacoma, Wash., the number of
companies with market caps of more
than $1 billion in the Russell 2000
slipped to 74 last week from 219
when the index peaked in April. On
Nasdaq, the number of such
larger-cap stocks declined in roughly
the same period to 219 from 303. The
vast majority of the companies on
Nasdaq are small, but the index is
weighted so that the large-cap stocks
have the most impact.
Some of the new small-cap stocks in fact were big growth prospects not too
long ago. According to research assembled by Prudential Securities, former
favorites like Reebok International, Lycos and Pier 1 Imports have fallen
more than 50% from their highs. Now classified as small-caps, the
companies could start attracting new interest from investors who once
dismissed the companies as too big.
"Small-cap investors are overwhelmed with the attractive ideas that are
coming their way from all these stocks that have fallen," says Paul
Greenwood, an analyst at Russell. "But they're a little traumatized," he adds.
A falling stock price that carries a once-big company into small-cap territory
isn't, by itself, an indicator of good value, warns Kobrick's Mr. Carmen. "It
depends how they got to that market-cap," he says. "If they got down there
because their fundamentals are not intact, then it's not as interesting."
For example, Novellus Systems, a semiconductor-equipment company
whose stock has fallen 63% back into small-cap territory, doesn't excite Mr.
Carmen as much as some other companies that have been hurt recently. He
says semiconductor demand prospects remain unclear, putting pressure on
the entire industry.
And while Montgomery's Mr. Skeen recommends a plethora of companies
that have fallen into small-cap territory, including electronics-outsourcing
company Flextronics International, and oil driller Stolt Comex Seaway, he
isn't recommending most financial-services companies. Other stocks Mr.
Skeen likes include computer retailer Micro Warehouse,
physician-management company Pediatrix Medical Group, and Eagle
Hardware & Garden, a retail chain that competes against Home Depot in
many markets.
So far, buyers have been hesitant to jump into mid-cap stocks that have
fallen back into the small segment. For one thing, buying interest from
small-cap portfolio managers will probably run into eager selling from
managers who prefer to tilt their own portfolios toward larger, more liquid
issues.
And that isn't to say there are lots of portfolio managers who are eager to
buy right now. With tax-loss selling unfolding in some stocks, the urgency to
buy has diminished, analysts say. "This year's conference is a little more
subdued than the go-go years of the past," says Jerry Castellini, a managing
partner with Loomis Sayles & Co. in Chicago. This year, "you don't have 16
guys rushing out of conference rooms to use their cell phones" and buy more
stock, he says.
Tuesday's Market Activity
Small-capitalization stocks rose by the slimmest of margins, underperforming
the rest of the stock market, which was moderately higher.
But the 0.01 gain eked out by the Russell 2000 small-cap index extended its
streak of positive sessions to three, the longest string of gains since the four
days ended July 16.
The Russell 2000 index of
small-capitalization stocks was up
0.01 at 357.73, and the Nasdaq
Composite Index, which finished at
1678.11, rose 12.42, or 0.75%.
PennCorp Financial Group fell 3/8, or
13% to 2 7/16 on the New York
Stock Exchange. The New York
insurance holding company, which
has been trying to sell some of its
assets to reduce its debt level,
announced it got an amended credit
agreement from its bank lenders. Under the new pact PennCorp agreed to
sell assets by year's end to reduce at least $100 million of its $434 million in
bank debt; to pay increased spread and other fees to the banks; and to get
the banks' approval if the sale of a key unit is for less than $225 million, with
less than $175 million in cash. PennCorp also pledged the capital stock of
some of its subsidiaries to collateralize the loans.
Cylink, a Sunnyvale, Calif., supplier of computer data-encryption products,
plummeted 2 3/4, or 35%, to 5 1/8 after saying its third-quarter results will
fall short of analysts' projections, with its revenue and profit falling below
second-quarter levels. Credit Suisse First Boston and PaineWebber lowered
their ratings on Cylink.
Rainforest Cafe dropped 1 13/16, or 22%, to 6 5/16. The Minneapolis
restaurant concern said its third-quarter profit will be less than analysts had
been expecting. The company also said its third-quarter same-store sales
will be down 16% to 18% from a year earlier.
Dress Barn was down 2 1/4, or 13%, to 15 3/8. Bear Stearns lowered its
rating on the Suffern, N.Y., retailer to neutral from attractive, citing its
unexpectedly weak August same-store sales, which Bear Stearns said calls
into question whether the company can meet its earnings projections.
PHP Healthcare dropped 1/2, or 20%, to 2 on the Big Board. The Reston,
Va., developer of health-care delivery networks reported a fiscal
first-quarter loss of $1.57 a share, compared with its year-earlier eight-cent
profit.
3DFX, a San Jose, Calif., developer of three-dimensional media processors,
fell 2, or 19%, to 8 13/16 after saying it expects to report a third-quarter
operating loss of "several million dollars," which compares with analysts'
projections of a profit of 47 cents a share. The company said it will post a
profit for the period because of its litigation settlement with Sega.
Cephalon, a West Chester, Pa., biopharmaceuticals concern, fell 1 3/16, or
18%, to 5 1/4 . Cephalon and Chiron withdrew their application seeking
marketing clearance in Europe for the Myotrophin injection treatment of
amyotrophic lateral sclerosis, or Lou Gehrig's disease. Cephalon said the
decision to withdraw was based on difficulties resolving differences in two
pivotal studies.
ACTV, a New York developer of television-related software technologies,
fell 13/32, or 15%, to 2 11/32. Liberty Media will acquire 10% of ACTV for
$5 million, and will have options to invest an additional $5 million in ACTV.
Dravo rocketed higher by 5 1/2, or 79%, to 12 7/16 on the Big Board after
the Pittsburgh maker of chemical-lime products agreed to be acquired by
Carmeuse Lime for $13 a share.
Genesis Direct, a Secaucus, N.J., direct marketer, surged 1 3/8, or 54%, to 3
15/16. The company completed the purchase of Cox Enterprises Inc.'s
Carol Wright Gifts unit for 2.4 million common shares and a $12.75 million
convertible note, which is convertible into one million shares of Genesis
Direct common stock at $12.75 a share.
BioSpecifics rose 1/2, or 12%, to 4 3/4 after the Lynbrook, N.Y.,
pharmaceuticals concern posted fiscal second-quarter earnings of seven
cents a share, compared with its year-earlier four-cent profit.
Equitrac gained 2, or 11%, to 19 1/2 following news the Coral Gables, Fla.,
provider of support services for computer hardware and software
communications networks signed an agreement with Xerox, under which
Xerox will market Equitrac's cost-recovery and resource-management
products.
On Nasdaq, declining issues led advancers, 2,117 to 1,897, on national
market volume of 632 million shares and overall volume of 664.8 million,
compared with 650 million and 686.7 million, respectively, Monday.
Tuesday's gains were the third in a row for the overall Nasdaq market, the
first time the technology-laden group has been able to string together three
consecutive gains since the three sessions that ended Aug. 7, during which
the Nasdaq Composite Index added 61.13. Over the past three trading days,
the Nasdaq composite pushed higher by 92.64.
"The market has somewhat calmed down," said Peter Coolidge, managing
director of equity trading at Brean Murray & Co. "The uncertainties seem to
have been worse than the realities."
-- Larry Bauman |
