Bargain-Hunting in the Small-Cap Patch

With the recent softening in prices, smaller company stocks may offer good value. Here are five--with strong balance sheets--that stand out

For managers of small-cap stock funds, the big challenge this year had been what to do with all the investor cash coming their way. Unlike large-company stocks, small-cap prices held up pretty well--until June. Suddenly, the bear caught up with shares of small companies. "They're getting less and less expensive--and maybe even cheap," says Eric Ende, a veteran small-cap specialist with First Pacific Advisors, who runs FPA's high-performing yet risk-averse Perennial, Paramount, and Source Capital funds.

As stock prices kept crumbling through late June, Ende stayed busy putting some of that idle cash to work. In search of remaining values as the quarter ended, I began quizzing Ende and other experienced small-cap stockpickers. Here's a shopping list of five small companies that stand out:

-- Cognex. Sales at this 21-year-old maker of "machine vision" gear--cameras that inspect manufacturing lines and guide robots--are off sharply amid the capital-spending crunch. Wall Street expects Cognex (CGNX ) to lose money for the full year, but Ende thinks it's closer to breakeven and sees earnings potential of about $1 a share. It lost 25 cents a share last year after making $1.49 in 2000. Meantime, Cognex has no long-term debt and wields more than $150 million in working capital.

-- LogicVision. Having gone public last November at $9 a share, LogicVision (LGVN ) saw its shares surge above $15. Now they're near $5, and RS Smaller Company Growth Fund manager Bill Wolfenden is buying. The company sells "self-test" circuit designs that semiconductor makers can embed on chips. They use LogicVision's circuits instead of external test gear to ensure that the microprocessor works correctly. The company owes no long-term debt and holds $45 million, or $3 a share, in cash and government securities.

-- Renal Care Group. An operator of dialysis centers in 26 states for patients with chronic kidney failure, this company's sales and earnings have been growing smartly. Last year, it posted a profit of $1.52 a share; FPA's Ende sees perhaps $1.75 this year. As with most any health-care stock, the potential for changes in government reimbursement policy poses a risk. And with the stock recently above $30, Renal Care (RCI ) remained on Ende's watch list. Where would he be a buyer? As the stock gets closer to $28 or so. At that, Renal Care would sell for little more than its rate of profit growth.

-- Topps. Shares in this maker of trading cards and candy for kids--it's responsible for the lollipop known as Baby Bottle Pop, a cavity creator if there ever was one--go in and out of fashion. With the fading of the Pokemon craze, to which Topps (TOPP ) contributed candy and stickers, sales and earnings have been shrinking. In the fiscal year ended last March, Topps earned 64 cents a share, and the Street sees profits sinking to 56 cents this year. It earned 17 cents in its fiscal first quarter. Royce & Associates managing director Whitney George nonetheless sees the stock as a buy at $10 or less--and thinks it's fairly valued at $12 to $13. Topps is debt-free and holds cash of more than $2.50 a share.

-- Verity. Yes, there may be value in an Internet stock. Verity (VRTY ) makes software for corporate intranets and Internet portals. Just as you would imagine, those sales have shrunk dramatically--down 35% in the fiscal year ended May 31. Yet Verity is profitable, having earned 4 cents a share in fiscal 2002, and the company sees revenue growing 15% to 20% in the year ahead. JohnsonFamily Small Cap Value Fund manager Wendell Perkins owns the stock, in part because he likes the company's balance sheet, which shows more than $4 a share in cash but no debt. Perkins also favors Verity's 22% market share, making it the leader in a highly fragmented industry.

Will all of these companies prosper? I can't say. But if you have cash to put to work in stocks, identifying financially strong companies like these and waiting for the sellers to offer a good price is a solid first step.

By Robert Barker

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