Shining a Light on Up-and-Coming Stocks

With everything from a strong economy to continuing mutual fund inflows being credited for fueling stocks, it’s easy to overlook one of the most basic forces behind the bull market: the fact that the U.S. keeps churning out promising young companies.

For investors, the goal is to identify up-and-comers early and ride their stocks higher as the companies grow larger and more successful.

To spotlight potential winners, the Chicago-based American Assn. of Individual Investors publishes an annual list of so-called shadow stocks. These are tiny companies that have minimal followings on Wall Street even though they’re profitable and have been around for at least five years.

A full 333 stocks made this year’s list, including 105 that are on it for the first time. In the accompanying chart, The Times lists the stocks with the highest average annual earnings-per-share growth rates during the last five years.

The lure of a shadow stock, of course, is that it can zoom if the company comes up with a key product or market niche.

“All of a sudden, you’ll see a name spike,” said Catherine Ryan, a portfolio manager at David L. Babson Inc. in Kansas City, Mo., which runs the Babson Shadow Stock mutual fund. “It’s like it’s waking up.”

Remember, though, that there’s no guarantee shadow stocks will do well. Investing in such “micro-cap” stocks is inherently riskier than buying shares of more established companies. And rapid earnings growth in the past doesn’t assure future earnings growth.

The AAII ran a computer screen to come up with its list, but it doesn’t vouch for any of the companies.

“Our goal is not to come up with a recommended list [of stocks to buy] but with a starting point for further analysis,” said John Bajkowski, editor of the AAII’s Computerized Investing newsletter. “Like any kind of stock, you have to really do your homework before investing in them.”

To make the list, companies had to meet three criteria:

* Market capitalization--stock price multiplied by the number of shares outstanding--must be between $20 million and $100 million.

* The company must have had positive earnings for two years and must have five years of data available.

* Ownership by institutions such as mutual funds and pension funds must be no more than 15%. Ideally, small investors want to latch on to small stocks just before they’re discovered by institutions, because buying pressure from big players can drive up the value of stocks.

At the same time, small investors want some institutional ownership to make sure daily volume is high enough that they can sell their holdings in a timely manner and without jolting the stock prices.

Finally, the AAII screened out financial companies such as banks and insurers because their income statements and balance sheets are not directly comparable to those of other companies.

Once a company makes the list for the first time, the AAII gives it a bit of leeway to deviate from the criteria. If a company’s market cap tops $150 million or dips below $10 million for two straight years, it’s taken off the list. If institutional ownership exceeds 30% for two years, the company is also dropped.

“Especially in a micro-cap stock, you see a couple of [big investors] interested and it goes through the roof,” Ryan said.

But it also can take some time for a stock to be discovered--if it happens at all--and a stock may not do all that much before it happens.

“If you’re buying something with a very low institutional ownership, it’s a waiting game,” Ryan said.

The Babson fund was created based on the broad principles of the shadow-stock list, though it doesn’t limit itself to the stocks on the list. The fund returned 27.6% in 1997, compared with a 22.2% return for the Russell 2,000 small-cap index. The fund is up 5.3% this year. It can be reached at (800) 422-2766.

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Emerging From the Shadows

The American Assn. of Individual Investors identifies largely unknown “shadow” stocks using its Stock Investor computer screening program. The 47 new shadow stocks with the highest five-year earnings per share (EPS) growth rates:

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Monday 5-year 5-year stock EPS sales price growth growth Company Ticker close rate rate Elantec Semiconductor ELNT $9.63 88.0% 19.7% Escalade ESCA 19.25 70.4 1.0 BF Enterprises BFEN 8.25 67.7 25.1 Judge Group JUDG 4.88 67.0 29.8 Quipp QUIP 16.44 64.1 10.7 Nanometrics NANO 10.00 58.0 11.0 EDO EDO 9.31 54.6 --8.3 Cal-Maine Foods CALM 6.19 54.2 4.5 Chad Therapeutics CTU 7.75 52.2 52.3 ASI Solutions ASIS 10.13 47.0 34.3 Panhandle Royalty PANRA 33.50 45.9 19.1 Miami Computer Supply MCSC 23.00 44.4 26.5 Symetrics Industries SYMT 14.94 43.4 33.4 Natl. Technical Systems NTSC 6.44 43.1 2.8 American Science & Engineering ASE 14.00 43.1 10.2 Royal Gold RGLD 5.00 41.7 141.4 Shuffle Master SHFL 10.75 41.0 NA Isramco ISRL 0.69 38.0 32.0 Xeta XETA 20.13 37.2 20.8 Lakeland Industries LAKE 8.75 35.5 10.1 Mity-Lite MITY 18.25 34.9 26.4 HealthCor Holdings HCOR 1.91 34.5 34.3 U.S. Physical Therapy USPH 11.89 32.2 115.1 Prophet 21 PXXI 13.25 32.0 10.7 Benthos BTHS 13.88 31.4 4.9 Petroleum Development PETD 5.88 31.1 22.7 Steven Madden SHOO 9.31 28.5 124.7 Team America TMAM 14.13 28.1 25.3 Exactech EXAC 7.25 27.5 41.9 Monarch Casino & Resort MCRI 5.75 26.9 27.4 Trans-Industries TRNI 12.88 26.8 4.8 Lifeway Foods LWAY 8.50 26.2 17.2 Dixon Ticonderoga DXT 13.19 24.9 6.2 Versar VSR 5.13 24.2 0.2 Paul-Son Gaming PSON 11.13 24.0 19.8 Chase CCF 17.25 23.7 12.2 Reading Entertainment RDGE 12.88 22.6 29.9 Pubco PUBO 11.50 22.3 --15.1 IMPCO Technologies IMCO 11.88 21.8 19.7 P & F Industries PFINA 7.00 19.9 6.2 Biacore International AB BCORY 8.50 19.6 51.7 Advanced Comm. Systems ACSC 9.38 18.9 43.1 Track ‘n Trail TKTL 7.75 18.8 11.6 Skymall SKYM 4.31 18.6 51.9 Star Gas Partners SGASZ 22.50 17.6 1.7 Datapoint DPT 3.00 17.3 --11.1 Interlott Technologies ILI 8.88 16.1 59.5

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NA: Not available

Company (Ticker): Industry

Elantec Semiconductor (ELNT): Analog integrated circuits

Escalade (ESCA): Sporting goods, office and graphic arts products

BF Enterprises (BFEN): Real estate development

Judge Group (JUDG): Information technology and engineering services

Quipp (QUIP): Material-handling equipment for newspaper industry

Nanometrics (NANO): Measurement tools for electronic manufacturing

EDO (EDO (9.31): Advanced electronic products

Cal-Maine Foods (CALM): Eggs and egg products

Chad Therapeutics (CTU): Respiratory-care devices

ASI Solutions (ASIS): Human resources outsourcing

Panhandle Royalty (PANRA): Mineral interests, oil and gas development

Miami Computer Supply (MCSC): Computer and office automation supplies

Symetrics Industries (SYMT): Electronic and telephone systems

Natl. Technical Systems (NTSC): Diversified technical services

American Science & Engineering (ASE): X-ray inspection systems for security

Royal Gold (RGLD): Gold properties and gold royalty interests

Shuffle Master (SHFL): Casino products

Isramco (ISRL): Oil and gas properties in Israel

Xeta (XETA): Telecommunications systems and services to lodging industry

Lakeland Industries (LAKE): Protective work clothing

Mity-Lite (MITY): Folding tables and stacking chairs

HealthCor Holdings (HCOR): Home-health-care services

U.S. Physical Therapy (USPH): Outpatient physical and occupational therapy clinics

Prophet 21 (PXXI): Online business management systems

Benthos (BTHS): Equipment for underwater exploration

Petroleum Development (PETD): Oil and natural gas mineral rights

Steven Madden (SHOO): Fashion footwear for women

Team America (TMAM): Human resource management services

Exactech (EXAC): Orthopedic implant devices

Monarch Casino & Resort (MCRI): Atlantis Casino Resort in Reno

Trans-Industries (TRNI): Lighting and information display for mass transit

Lifeway Foods (LWAY): Dairy products

Dixon Ticonderoga (DXT): Writing and art products

Versar (VSR): Environmental engineering and consulting

Paul-Son Gaming (PSON): Casino table gaming equipment

Chase (CCF): Protective coatings and tapes

Reading Entertainment (RDGE): Foreign movie theaters, U.S. art exhibits

Pubco (PUBO): Holding company for computer and construction products

IMPCO Technologies (IMCO): Equipment for internal combustion engines

P & F Industries (PFINA): Baseboard heating equipment

Biacore International AB (BCORY): Advanced scientific instruments

Advanced Comm. Systems (ACSC): Communications and information technology

Track ‘n Trail (TKTL): Footwear retailer

Skymall (SKYM): In-flight catalog company

Star Gas Partners (SGASZ): Retail distributor of propane and supplies

Datapoint (DPT): Communication products

Interlott Technologies (ILI): Lottery vending machines

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Sources: AAII’s Stock Investor, Market Guide