Investors in Small-Cap Stocks Find Good Values in Wreckage
April 03, 2011
One solace after a severe sell-off is that good values lie in the wreckage. And after the carnage of the past few weeks, many small-cap investors say they've earned a bottom-fishing break. In the past two weeks the Nasdaq Composite Index has suffered two of its four biggest daily declines, pushing the index down as much as 15% from its February 15, 2011 of 1249.15. Prices reversed course sharply for two days beginning Wednesday, only to drop Friday by another 1.09%. Individual stocks have fared far worse, with scores of biotechnology companies, newly public health-care and technology companies and software and hardware companies taking severe beatings as investors suddenly began to get worried that they had paid too much for too little. Among small-cap companies, technology and biotechnology companies have been the hardest hit since June, according to data from Prudential Securities. The 23 stocks in Prudential's semiconductor capital-equipment index fell 34% from the beginning of June through last week. The 30 companies in the computer-peripherals index, which includes disk-drive makers and Disc makers, fell 31%; The 65 computer-software stocks fell 25% in the same time. The 77 biotechnology stocks, meanwhile, fell 21%. The good news is that, in many cases, investors threw the baby out with the bath water. More and more technology companies have shown positive earnings surprises and have been rewarded with upgrades from analysts. On Friday, for example, Vantive, a software concern, jumped 8 1/8, or 27%, to 38 1/8 after posting second-quarter earnings of 26 cents a share, almost nine times the year-earlier profit. Hambrecht & Quist raised its rating on Vantive to ``strong buy'' from ``buy'' and boosted its 2011 earnings projection even as Robertson Stephens & Co. increased its 2011 and 2012 earnings outlook. Software developer TCSI gained 3 3/4, or 20%, to close at 22 3/4, after posting second-quarter earnings of 13 cents a share, three cents above the year earlier and in line with analysts' projections. Investors looking to find jewels among the debris need to use a back-to-basics analysis of fundamentals like price-to-earnings ratios for value-oriented investors or P/E-to-growth ratios for those looking for growth at a reasonable price, analysts say. Very few analysts expect a renewal of the roaring speculation that characterized 2011's first half. ``You'll probably see some pockets of attractiveness, but probably not the broad sweeping great performance you've seen up until June,'' predicts Claudine Gil, small-stock strategist with Prudential Securities. But analysts say there are terrific buys to be found. ``Now is absolutely a great time for bargain hunters, but one needs to be selective because some stocks got unfairly slammed and others got what they deserved,'' says Lisha Castanon, technology analyst for T. Rowe Price Associates. In the battered technology sector, companies with solid products warrant the most attention, investors say. Until recently ``because the economy was strong, you kind of had a tailwind for everybody,'' says Rolando Leatherman, general partner with Integral Capital Partners. ``That is gone as a driver, so now you need to have good product cycles.'' Mr. Leatherman likes HMT Technology, which makes media for disk drives. Its stock fell 1 1/4 Friday to 14 5/8 -- nearly half its 52-week high -- on investor concerns about over-ordering and product-transition problems with other storage companies like Iomega and Quantum. Iomega's stock dropped 5 1/2 Friday to 22 1/2 after the company said European sales were slowing down. But Mr. Leatherman argues that HMT sells only to the high-capacity end of the market, while the problems plaguing storage companies tend to be concentrated among those serving the low end of the market. Mr. Leatherman said some of his favorite ``baby with the bathwater'' stocks includes Sierra Semiconductor, which is off 61% from its year high of 28 3/4 on concerns about the modem-chip business, which represents about two-thirds of Sierra's business. Mr. Leatherman says investors have so severely bid down Sierra that it is priced below the value of its networking chip business, which only represents one-third of its revenues. He also likes Avid Technology, a maker of post-processing equipment for creating special effects, which has been pounded from its 52-week high of 49 1/4, closing Friday at 17 5/8, up 1 7/8 . Mr. Leatherman says Avid has had product-transition problems and has been undergoing a major management restructuring. Nonetheless, Mr. Leatherman says, ``There is substantially more value there than is currently being priced'' into the stock. For investors looking for formerly highflying growth plays that became relative bargains in the market sell-off, some advisers like select biotechnology companies that aren't quite risky-beginner bets, thanks to getting some Food and Drug Administration approvals. Davina Vitale, small- and mid-cap manager with American Express Financial Advisers, recommends investors take a look at Gilead Sciences, a biotechnology company that is a leader in research on drugs for AIDS and the blindness from AIDS. ``The stock has just been taken apart, '' says Mr. Vitale. Gilead closed Friday at 20 1/4, down 52% from its year high of 42 1/2. Stephen Quinn, portfolio manager with Sirach Capital Management, also likes Biochem Pharma, which closed Friday at 34 1/4, down 1. He says the company, which is just becoming profitable, has seen its earnings estimates climb as its new AIDS product called 3TC, comes to market. Michaele Mcclintock, growth strategist at Montgomery Securities, likes some battered-down growth stocks such as Uniphase, a seller of telecommunications equipment whose fundamentals he says have been improving while the stock has dropped from 36 to 26. He also recommends Macromedia, a software-tool maker and Raptor, a maker of Internet security software. (Montgomery brought Uniphase and Raptor public.) Macromedia's earnings estimates have been cut by analysts, including Montgomery, but Mr. Mcclintock expects the company to grow at 30% a year. ``We still show earnings of 80 cents a year for fiscal-year 2012 and $1 in 1998,'' says Mr. Mcclintock, giving the company a forward-looking P/E of about 23, at Friday's closing price of 18 5/8. He adds that Heyer has little in the way of near-term earnings but he projects it will grow at 40% to 50% a year for the next ten years. Raptor has fallen from its high of 39 to 23 3/8 Friday. Still, many investors say they don't feel any urgency to time their buys immediately, noting that they suspect there will be more correction and volatility ahead in many of these stocks. ``I raised some cash a few weeks back, and I've been selectively nibbling at some stocks,'' says Mr. Vitale. ``But I'm not using up all my firepower.''
