It was May of 1995, and I had the unshakable conviction that, after a year of submission to large-cap stocks, shares of little companies would rise. They didn't. The next year, I suspected a small-cap rebound was close at hand. It wasn't. Over the 1997-99 period, I guessed small caps might come back someday soon. Nope. With the new millennium, I turned agnostic.
You can imagine what happened next: Today, smaller stocks are pounding the big. As the year begins its final quarter, the Standard & Poor's SmallCap 600 index is up 8.5% (and S&P's MidCap 600 twice that), while the big-cap S&P 500 has slid 2.1%. It's not just the indexes. Morningstar reports that small-cap mutual funds are the year's top-performing group, except for sector funds.
Will the trend persist? Hey, I'm agnostic. Yet I must confess that the sight of small caps rising is as impossible to pull my eyes from as a lunar eclipse. To amateur investors, small caps can be things of bright beauty--easier than big companies to examine and, when the tide's with them, full of unexploited potential, since they're too small for most Big Money to mess with.
NEW MONEY. That's why I checked in recently with two strong small-company investors: Dick Gould, manager of Rockland Small Cap Growth Fund, and Irene Hoover, who runs Forward Hoover Small Cap Equity Fund. Both boast solid records and are enjoying a good year (table). While Gould prefers zippier growth stocks and Hoover tilts toward value, both keep a sharp eye out for risk. Hoover loaded up last year on such oil-service stocks as Global Marine (GLM) and Weatherford International (WFT). Now, after big runs in both and Wall Street suddenly loving energy stocks, she feels more nervous than greedy. "They're getting to the extreme phase," she told me. "I'm wondering whether I should be selling."
With fresh money, she's focusing instead on such glamorless names as American Italian Pasta (PLB). This Kansas City (Mo.) contract manufacturer makes the top-selling domestic brand, Mueller's, along with a bunch of private-label products for the likes of Wal-Mart (WMT) and Kroger (KR). Sales in the 12 months ended June grew 15%, to $245 million, and profit margins are expanding.
Hoover figures profits in the fiscal year ending Sept. 30 will rise about 20%, to $1.50 a share, and to $1.75 in fiscal 2001. At a recent price of $16.75, the stock sells for less than 10 times the 2001 estimate. Earlier this year, it traded above 31. What will drive it back up? Hoover points to the company's nearly complete program to expand and improve its factories. That means cash flow after capital spending, known on the Street as "free cash flow" and valued as a source of stock buybacks, is set to turn positive.
Gould lately has been buying another unfamiliar name: Anixter International (AXE), a distributor of telecom parts and equipment. Yet you probably have heard of Anixter's chairman, Sam Zell. The legendary Chicago vulture investor owns 16% of the stock. It peaked in August above 37. Now at $29.38, it's still up 50% on the year. Gould paid an average of about 30 a share.
The Skokie (Ill.) company last year made $1.24 a share, or $47 million from continuing operations on sales of $2.7 billion. As data traffic surges, Gould expects Anixter's sales to such customers as Nortel (NT) will follow suit. The Street sees $2.10 a share in earnings this year and $2.40 next. Gould told me he thinks fatter margins will help Anixter make over $3 a share in 2001. If he's right, the stock now sells for less than 10 times next year's profits. "It's a play on the Internet, without paying 100 times earnings," he said.
Because Gould runs a relatively small, $75 million fund, he can get in and out of stocks nimbly. That's an edge over the Big Money that amateurs enjoy, too--and another reason why small stocks are beautiful.
Questions? Comments? Send an e-mail to email@example.com or fax (321) 728-1711