Investing Small Is Beautiful

If we're to believe such financial honchos as the chief of the Federal Reserve, Ben Bernanke, and the CEO of JPMorgan Chase & Co., James Dimon, the worst of the credit crisis is behind us. Maybe so, but the steady stream of mammoth losses and dire warnings of billions more to come raises some doubt.

In any event, swelling loan losses suggest credit availability is constrained, giving credence to a broadly held view on Wall Street that the stocks of smaller companies, which are synonymous with less liquidity, should be avoided.

A veteran investment adviser, Richard Moroney, disagrees. He argues that small is beginning to look beautiful again, as shown in the performance of the Russell 2000 Index, which recently rebounded close to a three-month high. Likewise, small stocks have outperformed large stocks since early March. He further notes that smaller stocks tend to outperform as investors discount an economic recovery.

Mr. Moroney is the editor of Upside, a market-beating investment newsletter out of Hammond, Ind., that focuses on small and mid-cap stocks. When it comes to picking smaller stocks, Upside, as its track record shows, clearly merits a respectful hearing. Since its May 1999 inception, the letter's best buy list has gained 446.4%, Mr. Moroney says. In comparison, the Russell 2000 Index has risen 67.4%, while the S&P 500 is up 6.4%.

Laying out his top small fries, Mr. Moroney focuses on a number of companies that he feels can capitalize on the credit crunch through rock-solid balance sheets, impressive cash flow, solid track records, efficient operations, and the financial muscle to finance their own expansion.

Mr. Moroney's moneymaking strategy centers on four companies that offer the prospect of a 15% to 20% gain each over the next 12 months:

oAmedisys is an acquisition-minded provider of health care services, including home health agencies and hospices. As of year-end 2007, it had $13 million in debt, $56 million in cash, and over the preceding 12 months generated free cash flow of $64.5 million. Revenue has risen steadily over the past five years, posting a 40% annual growth rate, while profits have grown at an average 64% a year. While tougher Medicare reimbursement rules are likely to pressure competitors, Amedisys has already factored in the rules and says it's well-prepared for the change.

oEZCORP is an operator of a chain of pawnshops and lending stores, and has $13.65 million in cash, no debt, and a free cash flow last year of $1.06 a share. EZCORP's return on assets, equity, and investment have trended higher over the past six years. Sales between fiscal 2002 and fiscal 2007 rose 89%, while profits jumped to $37.9 million from $2.2 million. Consensus estimates project fiscal 2008 per-share earnings will rise 28%, to $1.13.

oSybase is a producer of systems software, and as of December 31 it had $702 million of cash versus $406 million of long-term debt, and free cash flow of $2.58 a share. Sales per employee jumped to $257 million last year after hovering between $212 million and $220 million between 2002 and 2006. Sales rose 17% last year, while income has been rising since 2004. Earnings in the March quarter surged 44% on a 13% sales increase, handily exceeding consensus estimates. An important plus: Reflecting an improving competitive position, the company has been able to raise prices. It also trades at about 15 times expected 2008 earnings, which is below its five-year average forward p/e of 16 and the software industry's average of 24.

oWatson Wyatt Worldwide is a global consulting firm that had $103 million in cash as of December 31, versus $107 million of long-term debt. In the past 12 months, the company had free cash flow of $184 million, or $4.34 a share. Returns on assets, equity, and investment have declined from their highs earlier in this decade. Since 2005, however, those measures have been on the rise again and are well above industry averages. The company has averaged a 16% sales growth rate over the last five years, with 20% average growth in net income. With solid cash flow, a history of successful acquisitions, and a global presence, Watson Wyatt seems well-positioned for both short- and long-term growth, Mr. Moroney says.

The bottom line: Don't lose sight of potential moneymaking peewee power in tackling the credit crunch.

dandordan@aol.com