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Bit of Pro Advice on Small Stocks

Three Managers With Varying Styles Offer Hints on Where They're Shopping

October 27, 1998|RUSS WILES

Small-company stocks are at a crossroads. After plummeting from late April through early October, many smaller issues have rebounded in recent weeks.

The Russell 2,000 index, a benchmark for the small-cap sector, plunged 37% between April 21 and Oct. 8. But the index has rebounded 20% since and has gained for nine straight sessions.

Have we seen the worst of the sell-off? Or is this a false start?

Besides the overall economic backdrop--specifically, concerns about a slowing economy in 1999--always-volatile smaller stocks face special issues at this time of year.

For example, many analysts warn that portfolio managers may still be unloading some of their biggest stock losers over the next couple of weeks to generate losses that can be used to offset capital gains for tax purposes. That could put new downward pressure on beaten-up smaller issues.

Still, many small-stock mutual fund managers say the carnage in these issues, which was far worse than the declines in most blue-chip stocks, has left some spectacular bargains for the picking.

Here, managers of three small-stock funds explain their strategies amid the market rebound. Although their investment styles differ, all three funds generally target stocks with market capitalizations (stock price times number of shares outstanding) under $1 billion, and all have performed better than the average small-stock fund over the last five years.

Berger Small Cap Value

A value investor, Berger Small Cap Value fund manager Robert Perkins scans the daily list of stocks hitting new 52-week lows to spot potential investments. "We like to buy stocks that already are down 60% to 70% from their highs," he said.

Perkins concedes that many of these laggards are depressed for a reason, so he must identify the problems and determine if they can be corrected within the next couple of quarters.

That's why he gravitates to companies that, although troubled, sport strong balance sheets. "The ideal is to find companies with a lot of cash but little debt," he said.

Perkins says he has no trouble finding purchase candidates these days. "The small-stock universe is cheaper than it has been at least since 1990," he said.

But he doesn't think small-cap investors are out of the woods yet, because he believes that blue-chip stocks remain overpriced and will need to retreat more before a sustained rally can advance. A big-cap decline could drag smaller stocks lower again as well.

"But once this washes out, there'll be a lot more money to be made in the small-cap arena," he said. "Small stocks offer much better values than any other area of the market."

Berger Small Cap Value normally maintains a cash position between 2% and 20% of assets. The position recently was at 8%, as Perkins has been adding stocks in several areas, including banks and thrifts such as Webster Financial (ticker symbol: WBST), a small Connecticut bank.

He also has been picking up "fallen growth" companies such as semiconductor equipment makers SpeedFam International (SFAM) and Brooks Automation (BRKS), which trades at less than two times cash flow. Another favorite is Cognex (CGNX), a robotics firm.

The fund also has a considerable weighting in telecommunications, energy and real estate stocks.

Its biggest holdings: CCB Financial (CCB), Knightsbridge Tankers (VLCCF), Jones Intercable (JOIN), Jostens (JOS) and Federal Signal (FSS).

Berger Small Cap Value has already paid a capital gains distribution of about $1 a share this year, so taxes don't pose much of a short-term consideration for investors mulling a purchase.

Eclipse Equity

This fund's co-managers, Kathy O'Connor and Wesley McCain, play it strictly by the numbers. They combine a value approach with "quantitative" analysis to identify stocks that are both "good and cheap."

For example, Eclipse Equity's holdings as of Sept. 30 featured stocks selling at an average price-to-book-value ratio of 1.9, a price-to-earnings ratio of 15.4 and a price-to-cash-flow figure of 8.8--all well below comparable readings for the small-company Russell 2,000 index.

"Our portfolio is designed always to be cheap to our universe of 4,400 small companies," McCain said.

That has helped power the fund to an 87% gain over the last five years, versus 59% for the average small-cap stock fund, according to Lipper Analytical Services.

McCain and O'Connor, unlike many small-stock managers, don't visit companies, nor do they consider profit and sales forecasts, because such estimates aren't entirely reliable. "We look only at past data," McCain said.

In addition, they steer clear of initial public offerings, partly because they prefer seasoned companies and partly because many firms time their initial stock sales to when their business prospects are near a cyclical peak.

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