Micro Stocks, Macro Gains?

William Blair's Cappy Price looks for giant values in small companies

It’s hard for small company stock pickers like Cappy E. Price not to feel a little neglected. For the last three years, they’ve watched as the stocks of mammoth corporations have soaked up all the attention. They’ve seen the S&P 500 rise 33% in 1997 alone, while their benchmark, the Russell 2000 index of small company stocks, managed just a 22.4% gain during the same period. They’ve had to endure listening to market expert after market expert crow on about the wonders of Intel, Gillette, Johnson & Johnson or GE.

Price realized that if she couldn’t join them, she’d have to beat them. Last year, her portfolio did just that to the tune of a 35.4% gain, which outdid the S&P. Those results also helped the William Blair Value Discovery Fund, which Price co-manages with colleagues David Mitchell and Glen Kleczka, to trounce the small company fund competition, which averaged a 15% gain in 1997 according to Lipper Analytical. And this year, Price’s record is holding up pretty well. Large caps remain on a tear–gaining almost 14% in the first quarter–yet the Blair Value Discovery Fund is within striking distance with a 12.8% total return to date, a figure that still leaves the Russell 2000′s 10.1% in the dust.

Price says her fund’s edge lies in the fact that its stocks are not only wee, but well off the radar screens of many big-time investors. “We look for companies that aren’t well covered on Wall Street,” she says. “We have to do more homework because there aren’t many sources for the companies we buy,” notes Price. “But that way, it’s almost like finding a secret out before the rest of the world takes notice.”

Relative obscurity is one thing. Solid fundamentals are another. Price and her colleagues run companies through a battery of tests before they pass muster. First off, the Value Discovery Fund limits its sights to companies with a market capitalization (stock price multiplied by number of shares outstanding) of $1.5 billion or less. Next, Price and crew screen for values: stocks selling at a price no more than 14 times estimated earnings for the year, a steep discount compared to the average P/E of 20 for the Russell 2000. Price then dives into a firm’s balance sheet to discard companies suffocating under a bloated debt burden. And to ferret out companies with a rock-solid base, Price looks for stocks with a price-to-book-value ratio of two or less. “Small companies are more volatile than large ones, so we look for something to cushion our investment, some solid support for the stock,” she says.

That’s not enough. Price says a company needs something nudging earnings upward to make the final grade. “We need a catalyst,” she stresses. If new management is knocking things around and stirring up a staid business, she’s interested. If new products are being developed or management is probing new channels to get goods to market, she feels a company is well worth her time.

Easco (Nasdaq: ESCO) is a

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