Boring Portfolio

Small Stocks Struggle
... Pentair, for example
by Greg Markus

SEATTLE, Wash. (Aug. 10, 1998) -- One indication of the depth of the malaise among small-cap stocks is that it made front-page news in the New York Times today.

As the Times pointed out, when the Russell 2000 index of smaller capitalization stocks hit a new 52-week low last Wednesday, it had lost 8.7% in 1998 and nearly 20% over the past 12 months, while the S&P 500 was up 11.4% in 1998 despite its sell-off. A gap that large -- in excess of 20 percentage points -- hasn't been seen in many decades, and it illustrates dramatically the narrowness of the channel into which equities investors' money has flowed during the past few years.

If there's any consolation from this news for small-cap investors, perhaps it's that when the revelation finally reaches the front page of the Times, it's a sign that the bottom is nigh.

At any rate, after recovering a bit late last week, small stocks struggled again on Monday. The Russell 2000 fell 1.00% in value, as compared with changes of -0.58% and -0.41% for the S&P 500 and Nasdaq, respectively. (For folks who get their stock quotes on AOL, the symbol for the Russell 2000 is $IUX.)

The Boring Portfolio's big dog, Cisco Systems (Nasdaq: CSCO) rose $2 5/16 to $99 3/16 on the heels of an upbeat story in The Washington Post over the weekend. That gain lifted the Borefolio into positive territory, although the majority of its smaller holdings were down -- if only nominally in most instances.

Leading the small- and mid-cap retreat were shares of Pentair (NYSE: PNR), which fell $1 9/16 to $35 15/16 in comparatively heavy trading. The stock was off by as much as $2 3/4 before recovering later in the day.

A call to the company elicited the response from CFO Richard Engman that the activity in the stock is "not at all justified" by anything that is happening in Pentair's business. Engman reiterated that the company remains comfortable with analysts' earnings estimates and that there has been no change in the company's outlook from that which was discussed in the recent conference call following Pentair's second-quarter earnings report.

According to First Call, the consensus forecast of four analysts who follow Pentair is that the company will earn $2.45 per share this year. That would constitute an 18% gain over 1997's $2.08. The 1999 estimate is $2.83, and the consensus long-term forecast is for annual earnings growth in the 15% range -- a number that is entirely compatible with Pentair's recent history.

For what it's worth, all four analysts rate Pentair as either a "strong buy" or a "buy."

At current prices, PNR is thus trading at less than 15 times projected 1998 earnings and less than 13 times the 1999 consensus forecast. The stock also provides a modest dividend and -- until recently, at least -- below-average volatility, as indicated by a "beta" of 0.73.

Pentair is only one example of a Borefolio small- or mid-cap stock that offers above-average growth at a below-average multiple... and that is nevertheless trading closer to its 52-week low than its yearly high. Take a look at Carlisle Companies (NYSE: CSL) or Borders Group (NYSE: BGP), and you'll see the same story.

Our REIT investment, FelCor Lodging Trust (NYSE: FCH) is suffering a somewhat similar fate. FCH stock has been clobbered for no good reason -- and certainly not for any reason that the FelCor insiders who have been relentlessly buying the stock all year long can discern.

The hotel industry has faced with two major challenges this year. The first is a spate of overbuilding in the "economy" segment of the industry. The second is a legislative change that effectively ends the advantage enjoyed by the handful of so-called "paired-share" REITs, which are able to both own and operate hotel properties.

It will surprise you not at all, I suspect, to hear that neither of these circumstances bears on FelCor. FelCor is focused firmly on upscale and full-service hotels, and it is not a paired share REIT. (Indeed, it is the largest of the non-paired-share lodging REITs.)

Shares of Andrew Corp. (NYSE: ANDW) are also scraping bottom. In Andrew's case, there is a least a rationale: the company's sales of telecommunications antennas, cable, and related equipment are flat, due primarily to ailing Asian economies and a maturing domestic cellular industry.

That said, Andrew is solidly profitable and an established leader in its industry. The long-term trajectory for telecommunications -- and thereby for Andrew -- is inarguably up. And with the stock trading at a price-earnings multiple in the low teens, ANDW is a value-oriented investor's dream.

Even if at the moment the market is, for value investors, more along the lines of "Halloween H20."

FoolWatch -- It's what's going on at the Fool today.

08/10/98 Close

Stock  Change    Bid 
 ANDW  -  1/8   16.00 
 CGO   -  1/16  34.88 
 BGP   -  1/16  30.00 
 CSL   -  1/16  43.44 
 CSCO  +2 5/16  99.19 
 FCH   -  1/16  26.06 
 PNR   -1 9/16  35.94 
 TBY     ---    7.44 
                   Day   Month    Year  History 
         BORING   +0.17%  -2.74%  -2.56%  22.61% 
         S&P:     -0.58%  -3.35%  11.61%  74.24% 
         NASDAQ:  -0.41%  -1.77%  17.12%  76.68% 
     Rec'd   #  Security     In At       Now    Change 
   6/26/96  150 Cisco Syst    35.93     99.19   176.03% 
   2/28/96  400 Borders Gr    11.26     30.00   166.52% 
   8/13/96  200 Carlisle C    26.32     43.44    65.01% 
    3/5/97  150 Atlas Air     23.06     34.88    51.25% 
   4/14/98  100 Pentair       43.74     35.94   -17.84% 
   5/20/98  400 TCBY Enter    10.05      7.44   -25.96% 
   11/6/97  200 FelCor Sui    37.59     26.06   -30.67% 
   1/21/98  200 Andrew Cor    26.09     16.00   -38.67% 
     Rec'd   #  Security     In At     Value    Change 
   6/26/96  150 Cisco Syst  5389.99  14878.13  $9488.14 
   2/28/96  400 Borders Gr  4502.49  12000.00  $7497.51 
   8/13/96  200 Carlisle C  5264.99   8687.50  $3422.51 
    3/5/97  150 Atlas Air   3458.74   5231.25  $1772.51 
   4/14/98  100 Pentair     4374.25   3593.75  -$780.50 
   5/20/98  400 TCBY Enter  4018.00   2975.00 -$1043.00 
   1/21/98  200 Andrew Cor  5218.00   3200.00 -$2018.00 
   11/6/97  200 FelCor Sui  7518.00   5212.50 -$2305.50 
                              CASH   $5528.69 
                             TOTAL  $61306.82