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Posted 4/7/2004
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By Jon Markman
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Revenge of the small and strange stocks
StockScouters first-quarter fetish for energy stocks was right on the money. Guess what it likes for Q2? A scrap-metal dealer, a shoe seller and a chicken-farmer, among others.
By Jon D. Markman
At the start of this year, MSNs StockScouter ratings forecast an unlikely first-quarter bull market in the shares of energy and energy-transportation companies. And despite all odds, one did transpire, sending the stocks of highly rated shipping companies such as Tsakos Energy Navigation (TNP, news, msgs), General Maritime (GMR, news, msgs) and Stelmar Shipping (SJH, news, msgs) up 35% to 60% from January through March -- a time period when the broad market indexes languished.
As a new quarter begins, those companies are still highly rated by StockScouter, MSN Moneys proprietary, objective system for rating 5,500 stocks trading on U.S. exchanges. But they have been supplanted at the topmost rung by an eclectic group of outfits ranging from a chicken farmer and a scrap-metal processor to an animal-health diagnostics maker and an athletic-shoe retailer. Our top 25, compiled via this screen on Friday, April 2, are listed in the table below.
| StockScouter top 25 for the second quarter | | Company | Rating | Market cap | Last price | | Sanderson Farms (SAFM, news, msgs) | 10 | 767 million | $39.05 | | Metal Management (MTLM, news, msgs) | 10 | 431 million | $39.00 | | TV Azteca (TZA, news, msgs) | 10 | 1.8 billion | $9.86 | | Forward Air (FWRD, news, msgs) | 10 | 719 million | $33.42 | | IDEXX Laboratories (IDXX, news, msgs) | 10 | 2.1 billion | $59.55 | | Foot Locker (FL, news, msgs) | 10 | 3.7 billion | $26.00 | | Affiliated Computer Services (ACS, news, msgs) | 10 | 7.1 billion | $54.45 | | Encore Wire (WIRE, news, msgs) | 9 | 592 million | $38.70 | | Perrigo (PRGO, news, msgs) | 10 | 1.4 billion | $20.54 | | Univision Communications (UVN, news, msgs) | 10 | 11 billion | $34.27 | | eBay (EBAY, news, msgs) | 10 | 48 billion | $73.77 | | Oxford Health Plans (OHP, news, msgs) | 10 | 4.1 billion | $50.32 | | Coventry Health Care (CVH, news, msgs) | 10 | 3.8 billion | $43.47 | | Techne (TECH, news, msgs) | 10 | 1.7 billion | $42.06 | | United Natural Foods (UNFI, news, msgs) | 10 | 967 million | $48.90 | | Columbia Sportswear (COLM, news, msgs) | 10 | 2.3 billion | $57.56 | | Getty Images (GYI, news, msgs) | 10 | 3.2 billion | $55.11 | | Canadian Natural Resource (CNQ, news, msgs) | 10 | 7.6 billion | $57.13 | | Genentech (DNA, news, msgs) | 10 | 58 billion | $110.70 | | Yahoo! (YHOO, news, msgs) | 10 | 33 billion | $50.15 | | PartnerRe (PRE, news, msgs) | 9 | 3.1 billion | $57.52 | | Abercrombie & Fitch (ANF, news, msgs) | 10 | 3.3 billion | $34.40 | | Choice Hotels Intl. (CHH, news, msgs) | 10 | 1.5 billion | $45.59 | | Patina Oil & Gas (POG, news, msgs) | 10 | 1.8 billion | $25.95 | | Shuffle Master (SHFL, news, msgs) | 10 | 772 million | $46.50 |
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Revenge of the small and strange
The obscurity of most of these well-regarded companies is emblematic of the tremendous advance that smaller stocks have made in the past year. For all the pageantry of the rebound in the S&P 500 Index ($INX) and the Nasdaq 100 ($NDX.X) last year, those large-company proxies are still well off the historic highs they set back in 2000 -- 65% off, in fact, in the case of the latter.
In contrast, the S&P Smallcap 600 Index ($SML.X) set an all-time high on Friday, and the S&P Midcap 400 Index ($MID.X) is just a whisker away from a similar feat. The success of these two sets of stocks, which broadly represent about 90% of all stocks available for trading in the market, shows just how widespread and fundamental the surge in investor enthusiasm has been over the past year.
For the many investors still stuck in the late-1990s time warp of focusing on big techs such as Dell (DELL, news, msgs) and Oracle (ORCL, news, msgs), this renaissance of lowbrow, niche businesses is hard to grasp. But eventually it will sink in. With the exception of Internet plays eBay (EBAY, news, msgs) and Yahoo! (YHOO, news, msgs), every time the market has had an opportunity to shine a favorable light on the nations leading big brands again, it has sidestepped them in favor of the small and strange.
The difference was clear in just the past few weeks. During the bounce back from lows set on March 23, not a single widely recognizable large-cap stock was among the markets 200 top gainers. To be sure, the rebound began with nice moves in cyclical goliaths such as Boeing (BA, news, msgs). But as soon as active traders determined that a tenable bottom was in place, they ditched the old reliables for speculative plays in fields more highly leveraged to nascent global economic growth.
StockScouters winning picks
Why are stocks such as Sanderson Farms (SAFM, news, msgs), Metal Management (MTLM, news, msgs), IDEXX Laboratories (IDXX, news, msgs) and Encore Wire (WIRE, news, msgs) attracting so much more interest than Boeing and Merck (MRK, news, msgs)? The StockScouters rating systems suggests that these stocks simply have stronger fundamental growth rates, better valuations, and in a few cases, are being accumulated by their top executives and board directors. If there are any problems, it is that insider selling for many of these has picked up a lot recently. Yet the system will still help you leverage a tested mathematical model to pick stocks, rather than your memory of past greatness.
StockScouter, you may recall, rates stocks from 1-10 on their likelihood of low-volatility gains six months out, with 10 being best. Our list includes some lower-ranked stocks, however, because the very best stocks are ones rated 8 and above that also have the highest average in-favor tailwinds, or market preference scores. Currently, StockScouter rates all sectors and market cap sizes as neutral. The systems Top 50 portfolio was up 52% in 2003 and is off to a solid start in 2004. The 20 stocks listed in SuperModels on Jan. 7 are up 9% as a group, versus a negative 1% return for the broad market. Another group of Top 13 listed in SuperModels on Feb. 25 is up 7%.
Now heres a closer look at three of the more interesting new names:- Coventry Health Care, a medical plan provider in the mid-Atlantic, Midwest and Southeast, has been a cash-flow generating machine for the past several years. The valuation and earnings growth have been terrific, but the key to the stock now is improved employment growth in its regions. According to UBS Investment Research analysis, every 10 basis-point improvement in the national unemployment rate equates to 147,000 more people entering medical health plans. Coventry is seeing the strongest relative uptrends in enrollment capacity among all regional plan providers, with unemployment in its regions at 4.9% vs. the national average at 5.4%. The UBS analysts say they expect Coventry to grow enrollment at 3-5% this year, which combined with improved pricing and a reduction in costs should continue to provide a lift to earnings growth. The company is considered a leader in customer service and technology, so it also feeds into investors hunt for consolidation plays in this highly fractured industry; it would make an ideal acquisition for a national player.
- Encore Wire is a manufacturer of low-cost copper electrical building wire and cable for the home and residential markets. The companys shares have traced out a pattern very typical of its small-cap breed. First of all, corporate insiders were heavily buying the stock in the fall and winter. Then in early February, it reported fourth-quarter earnings that were about double the level that analysts expected and more than 10 times better than the quarter in the prior year. Operating margins improved, and it was able to pass along the rising cost of copper to customers. Analysts then raised their estimates by a whole bunch, putting their expectation for the stock at a level equal to the companys prior earnings cycle peak. But the market is now betting that analysts are just as wrong now as they were the last time, and have pushed the stock to historic highs. Vice Chairman Donald E. Courtney certainly put his money on the line, buying more than $500,000 worth of the stock on the open market even after the February earnings blowout. His last purchase was 7,300 shares at $27.50 to $29. Shares still seem reasonably priced at 21 times estimated 2004 earnings, which is fine for a company growing at least 20% a year, and the balance sheet is solid. Through the end of last year, the stock was owned only by a couple of small-cap value mutual funds, and you can bet your bottom piece of copper wire that it is now under accumulation by at least a couple of small small-cap growth funds.
- IDEXX Laboratories shareholders dont have the insider buying to fall back on for value, but virtually everything else is in place. The manufacturer of diagnostic products for veterinarians -- including a mad cow test -- preannounced a much stronger-than-expected first quarter and forecast a good follow-up quarter. It saw its shares stampede past its 1995 top recently to a new high. Shares now trade at 30 times next years estimated earnings, but since analysts continue to be surprised by this market-leading companys ability to churn out high-margin, unique large-animal drugs and clinical tools without incurring debt, the price is probably fair.
Thats an eclectic trio -- managed care, residential and commercial wiring, and veterinary services. They may not be exciting, but any of them -- or the other 22 -- should scout the way for steady gains in the spring quarter.
Fine Print
My last column, For American brands, the world turns ugly, generated a lot of reader comment. View a selection of the mail at my personal Web site. . . . To learn more about Coventry, visit its Web site. . . . Learn all about Encore Wire here. . . . IDEXX explains the intricacies of its diagnostics for pets (which it calls companion animals) and mad cow testing here. . . . Mr. P called over the weekend to say that his forecast for a largely flat but volatile year -- articulated in my 2004 predictions column -- is still on track. In that Dec. 31 column, he said, Returns for investors will come from buying sell-offs during periodic high-volatility events associated with terrorism risk . . . and big moves in currencies and commodities. The past decline associated with the bombing in Spain qualified as one of those dips that active traders needed to buy. Since the end of last week, he turned generally bullish for stocks until around mid-June. If his view changes, Ill let you know. . . . For what its worth, Paul Desmond of Lowrys Reports, who has also proven an able forecaster, said this week that his work also suggests continued strength in equities, particularly for small caps and mid-caps.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdmmail@fastmail.fm. At the time of publication, Markman had a position in the following securities mentioned in this column: Perrigo, TV Azteca.
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