Small-cap stocks have been a bonanza for Ken Burgess. He runs Systematic Financial Management's Small Capitalization Value Equity. From Jan. 2 to Dec. 27, 1996, his fund scored a hefty 29.6% gain--well above 14.3% for the Russell small cap index and 24.8% for the Standard & Poor's 500-stock index.
Burgess looks for outfits whose stock prices are low relative to their operating cash flow and free cash flow (after deductions for capital expenditures, taxes, and dividends). Burgess believes small caps still represent the best value in the market. His two top picks: Brookstone (BKST), a specialty retailer that's trading at 12 times free cash flow, and STB Systems (STBI), one of the major supplier of graphics adapters for IBM-compatible desktop PCs.
Brookstone operates 131 stores in 30 states that market all sorts of high-tech household gadgets. The stores are located in malls and in such big-city shopping meccas as Boston's Quincy Market and New York's South Street Seaport. Sales have been robust and are expected to climb 22% in the current quarter.
The company is in the process of remodeling stores. Sales at revamped stores have outstripped those at unrenovated ones--20% growth vs. 5%, according to Burgess. So he thinks the stock price, now 10, could soon hit 15.
Burgess is impressed with STB's stunning sales and this year's 50% earnings growth. He expects long-term growth to be 30%. Although the stock has made a big move, it is still undervalued, he says, based on free cash flow and earnings. His target for STB stock, now at 20, is 35. The company's top customers include computer makers Gateway 2000 and Acer America, along with computer retailer CompUSA.