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Betting on Potential Blue Chips

By Gene Marcial Who in this dismal market environment advocates that investors go into the universe of small- and mid-cap stocks? One unlikely proponent is Goldman Sachs, the giant investment bank and securities firm widely known as the champion of large-caps. No less than Abby Joseph Cohen, Goldman Sachs' chief investment strategist, predicts that a "favorable macro environment for small- and mid-cap investing" is in the cards. The stage is set, she says, for a "solid price appreciation" for the smaller stocks.

Marc Robins, editor in chief of RedChip Review, which tracks the stocks in this world, couldn't agree more. He says investors who do their homework and scan the investment horizon for fundamentally attractive small-cap companies could come up with gigantic winners -- as RedChip Review's top 30 stock picks turned out to be in 2000, he adds. RedChip's 30 stocks, with a market cap ranging from $200 million to $1.5 billion, posted a hefty gain of 26.8% last year, vs. a loss of 5% in the Russell 2000 and the S&P 500's loss of 10.8%.

Robins expects RedChip Review's picks for 2001 to also perform as well -- if not better -- given Federal Reserve Board Chairman Alan Greenspan's recent surprise 50-basis-point interest rate cut. That signaled to investors that the Fed had committed itself to averting a recession and to ensure an economic soft landing, says Robins.

HEFTY GAINS. The three best perfornmers in last year's RedChip portfolio: LJL Biosystems (LJLB), a developer of products that accelerate and enhance the process of discovering new drugs, which rocketed 365% mainly due to its acquisition by Molecular Devices (MDCC); Integra LifeSciences Holdings, which develops and makes medical devices used in the treatment of burns, spinal disorders, and orthopedics, which advanced 137%; and Measurement Specialties (MSS), which jumped 121.2%.

Two other highly favored stocks in the list: Excel Technology (XLTC), a maker of laser systems and electro-optical components for industry, science, and medicine; and Frontier Airlines (FRNT), a low-fare full-service commercial airline that has hub operations in Denver.

Robins is again including Measurement Specialties in its top-ranked stocks for 2001. The company makes sensors and sensor-based electronic measurement devices for consumer and industrial products, such as scales, tire-pressure gauges, and distance-measuring devices. Robins notes that Measurement grew over the years through its strong technology and prudent acquisitions. The company split its stock two-for-one last year, when its earnings and stock price, currently trading at around 16 1/2, hit record highs.

"That may be a tough act to follow," says Robins. "But our confidence in its business model and management's ability to execute it leads us to expect another great year for MSS," says Robins.

LITTLE CHIP EXPOSURE. As for Excel, the stock had quite a roller-coaster ride last year, running up from the mid-teens to 53 before pulling back to 22. It has since bumped up to around 25 1/2. Analyst Matthew Desmond of RedChip Review says some misperception that tended to lump the company with laser companies that have a lot of exposure to the semiconductor industry hurt the stock last year. But the company has relatively minor sales to chip-related companies, says Desmond. Its sales and opportunities lie in other industrial processes and in micromachining industries.

Excel, says the analyst, tends to be "more profitable and has a healthier balance sheet than its peers, yet it receives what we consider an unfairly lower valuation." The company has racked up a five-year compounded annual growth rate of nealy 25%. "It is bound to continue its strong growth record," says Desmond, who expects it to earn $1.60 a share this year, up from last year's estimated $1.33.

Frontier Airlines, which competes with United Airlines in its routes, has garnered significant passenger gains, says Lantz Stringham, an analyst who covers airlines at RedChip. The airline's expansion strategy and earnings momentum, he says, should boost the stock even more, although it's now trading close to its high at 31. "Based on revenues and earnings growth, Frontier is the industry's fastest-growing airline," argues Stringham.

LOFTIER ALTITUDE? Yet its stock remains inexpensive compared to its many of its highflying peers, which trade at more than 20 times earnings. Frontier trades at a price-earnings ratio of just 13 times trailing 12-month earnings. He thinks Frontier will earn $3.30 a share in fiscal 2002 ending Mar. 30. This estimate, says the analyst, doesn't take into account the upside earnings potential that could be delivered by any drop in oil prices or prolonged difficulties at United Airlines.

Robins says RedChip Review's primary purpose is to "discover tomorrow's blue chips." Measurement Specialties, Excel Technology, and Frontier Airlines, he says, are clear examples of companies that have such star quality. Marcial is Business Week's Inside Wall Street columnist

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