Prospects
Intact For Select Small Caps
By Richard Moroney, editor
Low Priced Stock Survey
Small-company
stocks had managed to hold their own for most of 2002. Then came
July. For the month through July 30, the S&P SmallCap 600
Index dropped about 12%. The Russell 2000 tumbled 13%. Both indexes
are down more than 22% from highs set in April.
In our view, the recent
retreat in small-company stocks has made an attractive sector
even more appealing. Does that mean that small stocks will surge
once investors refocus on the sector's solid fundamentals? Not
necessarily. But many small stocks are cheap given their growth
prospects, making the sector a good place to look, for buy ideas.
Consider the following:
A mere 6% of the stocks
in S&P SmallCap 600 Index are trading above their 50-day
moving average price. Only 113 stocks, roughly 19%, trade above
their 200-day-moving average price one of the lowest figures
in recent years.
The average stock in
the index is down 37% from its 52-week high price. Nearly one
out of every four stocks is at least 50% below its 52-week high.
Entering July, the
average stock in the S&P 600 had a price/earnings ratio of
28. Now that ratio is 23. Based on consensus current-year earnings
estimates, the average forward P/E is about 19.
On average, June-quarter
earnings for small companies have been better than expected with
year-to-year profit growth more than double the average of large
companies.
Small companies are
not nearly as debt-heavy as their large counterparts, so balance
sheets remain in relatively good shape.
In the following paragraphs,
the Survey profiles four new selections. All four have
good earnings momentum, reasonable valuations, and bright year-ahead
growth prospects.
Applebee's International
(Nasdaq APPB $23) operates more than 1,400 casual dining
restaurants in 49 states and seven countries. A strong franchise
system (roughly 80% of the restaurants are franchised) has delivered
steady growth generate per share have increased every year since
1988. Despite fierce competition in the casual dining market,
Applebee's has generated solid same-store sales growth. A strong
balance sheet and healthy free cash flow should fund stock repurchases
and new stores. The shares trade at 15 times expected 2002 earnings
of $1.43 and 13 times 2003 estimates of $1.63. June-quarter earnings
came out after the Survey went to press. Wall Street was
expecting $0.36 versus $0.31 in 2001. The Survey is initiating
coverage with a Best Buy rating.
With over $1 billion
in annual sales, Apria (NYSE AHG $24) provides home-respiratory
therapy, infusion services, and medical equipment through some
400 branches in 50 states. June-quarter earnings jumped 38%,
to $0.47 per share, beating the consensus estimate of $0.42.
Sales rose 10% to $310 million. Cost controls and stock repurchases
have bolstered per-share earnings. Annual earnings growth is
expected to be around 18% over the next five years. While that
forecast seems a bit optimistic, growth of 13% to 16% seems achievable.
The outlook for Medicare reimbursement rates is a wild card.
The stock trades at 13 times expected 2002 earnings of $1.83,
a large discount to rival Lincare Holdings. Some discount is
justified given Apria's choppy earnings history and relatively
leveraged balance sheet. But Apria appears poised for solid growth
given its steady cash flow for acquisitions and improving balance
sheet. The Survey is initiating coverage with a Buy rating.
THQ (Nasdaq THQI $24), a leading publisher of video game software, seems positioned for strong near-term gains. The video game industry, keyed by new game consoles, is in the "sweet spot" of its cycle. The company boasts a substantial game line up, including Scooby-Doo and WWF WrestleMania. THQ has 86 titles under development, of which 45 are expected to be released over the next five months. At the end of June, the company had no long-term debt and $229 million in cash ($5.44 per share). Backing out cash, the shares trade at only 15 times expected 2002 earnings of $1.28 per share a deep discount to its main rivals. Yet profits are expected to soar 27% this year, and another 23% in 2003. THQ is rated Best Buy.
Editor's Note: Richard Moroney is editor of Low Priced Stock Survey, a supplement to the weekly Dow Theory Forecasts.
Horizon Investment Services recently introduced a new investment portfolio service focused exclusively on small-cap and low-priced stocks.
Horizon Investment Services is offering portfolios invested exclusively in small-cap stocks based on the same stock methodology used in the Low Priced Stock Survey.
Horizon Investment Services, founded in 1997, is a sister company of Horizon Publishing, which has been publishing investment newsletters, including Dow Theory Forecasts and the Low Priced Stock Survey, for individual investors since 1946.
Minimum investment is $150,000. For more information write to Small-Cap Managed Portfolio Service, 7412 Calumet Ave., Hammond, IN 46324 or call Richard Moroney or Chuck Carlson at 1-800-711-7969.
