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Market Savvy

Some Mid-Caps With Potential

Investing: Screening for reasonable prices and low debt produces a short list of 18 stocks.

November 04, 1998|JOSH FRIEDMAN | TIMES STAFF WRITER

Recession, slowdown, credit crunch. Whatever the economy brings in 1999, some companies will surely prosper.

But how to find them?

Here's one idea: Look for reasonably priced stocks of mid-sized companies expected to post decent earnings growth in the next few years.

And to lower your risk in case the economy becomes much more challenging, pick companies with little or no debt on their balance sheets.

As Ron Muhlenkamp, manager of the Muhlenkamp Fund, puts it: "If you don't owe people money, you can't get into too much trouble."

That may be overstating, but a company with strong finances certainly has one less thing to worry about if times get tougher.

Using Microsoft Investor's database of 8,796 companies, we used four criteria to find fast-growing mid-cap companies unburdened by debt and selling for reasonable valuations.

First, we screened for market capitalization--a company's value as measured by stock price times shares outstanding--of at least $750 million but less than $5 billion, the rough definition of a mid-cap.

Some analysts believe mid-cap stocks offer a winning combination in the current market environment: more stability and liquidity than smaller stocks, and more growth potential than many mature blue chips.

Then we demanded that long-term debt (total obligations due in one year or longer) amount to no more than 20% of a company's total shareholder equity, or capital. Though "appropriate" debt levels vary by industry, a 20% or lower debt-to-equity ratio is generally considered a low level.

Next we required that a company's stock price-to-earnings ratio be 25 or lower, based on analysts' 1999 per-share earnings estimates. That P/E is roughly the benchmark Standard & Poor's 500 index's estimated P/E for 1999.

Finally, we limited our list to companies whose earnings growth, as projected by the analysts who cover the companies, is 15% or better for this year, 1999 and the next five years (annualized)--since a good balance sheet doesn't do much if the company isn't growing.

We ended up with 18 companies, as shown in the chart above.

Despite the market's recent comeback, many of the stocks on our list, including consulting firm Gartner Group, retailer Cracker Barrel Old Country Store and energy drilling contractor Noble Drilling, remain down about 50% from their 52-week peaks.

Low debt and high earnings growth forecasts don't assure success, of course, but for investors hunting for opportunities today, this list may be a place to start.

Details on some of the firms:

* Cadence Design Systems of San Jose provides software tools used to speed and manage the development of semiconductors, computer systems and other electronic products. The company, which has strengthened its "system-on-a-chip" leadership position through acquisitions, reported a third-quarter sales rise of 31% over the same period a year ago, and 21% higher operating profit.

* CMAC Investment Corp. of Philadelphia, holding company for Commonwealth Mortgage Assurance, got a jolt recently when the House passed a bill that may allow Freddie Mac to self-insure low-down-payment mortgages. The change could increase competition and crimp long-term profits for firms such as CMAC.

"Investors are nervous about the group," said analyst David Hochstim of Bear Stearns, who nonetheless rates the stock a "buy," noting the company's rising market share.

"The stock has been driven down to a level that suggests the company has no future," he said. "And that's absurd."

* Gartner Group of Boston, one of the leading names in information technology consulting, serves more than 8,300 clients worldwide.

Value Line Investment Survey expects corporate IT-related spending to grow 17% a year through 2002, with Gartner's earnings rising faster as it widens its global reach. The company has an 85% client-retention rate and a juicy target market (firms with more than $100 million in annual revenue) with just 20% penetration.

The future looks bright--at least until someone invents a machine that puts all the consultants out of business.

* Parametric Technology of Waltham, Mass., supplies software used to automate product development. It might be the riskiest stock of the bunch, as its exposure to Asia and other overseas markets has scared some investors.

The stock was hammered as third-quarter operating earnings rose a disappointing 13%, and as Parametric announced a sales force restructuring. But management expects increased bundling of products to help drive future growth.

* Rexall Sundown of Boca Raton, Fla., which markets vitamins and other health products, joined Fortune magazine's list of the 100 fastest-growing U.S. companies last month.

The company reported quarterly sales growth of 73% and profit growth of 81%, but its shares, at $19.75 now, still languish nearly half off their March peak. The board authorized a $100-million stock buyback this fall.

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