Oberweis on small caps: Now is the time
Jim Oberweis is president and lead portfolio manager of Oberweis Asset Management and president of The Oberweis Funds. Oberweis Asset Management, Inc. is a growth equity investment management firm that manages approximately $1.5 billion in micro, small, and small/mid capitalization growth strategies globally, primarily for institutional investors and its own proprietary mutual fund family. Oberweis is a Chartered Financial Analyst. He earned an MBA with high honors from the University of Chicago and a B.S. in Computer Science from the University of Illinois.
SmallCapInvestor.com’s Jennifer Schonberger interviewed Oberweis last week about his outlook for small caps and some of his specific small-cap recommendations.
“Valuations have been pushed down to a point where there are above-average opportunities now with our universe of smaller, high-growth companies. Maybe once a decade you see — for whatever reason — uncertainty and fear in the marketplace push valuations down to a point where even a modest improvement in sentiment for an uncertain economic outlook can dramatically shift the momentum of stock prices. The best example I can give you is 1990, where we saw a similar drop in prices. In 1991, we probably saw the biggest rise ever for smaller growth stocks.
“At some point the valuations are so low that the marginal risk associated with negative news is really not that high. The market already expects everything to be terrible. So if everything is terrible, that’s meeting expectations. If things come out to be not as terrible as people expect, prices will go up. We can tell based on the mathematics of valuations that we’re about as low as we’ve ever been in the last decade. [The recession and the bad news] is completely priced in. Despite horrific results for small growth stocks in the past six or seven months I think they’re very well-positioned going forward on a prospective basis.
“I think (first quarter) earnings will be lousy. They’ll probably remain subdued for the rest of the year. When we get into these types of environments, investors don’t tend to look at the next quarter. They’re discounting the possibility of this continuing on for the next several years. As soon as you see the first rays of sunshine, that’s when you start to see the market ignite. The market has to pursue the actual economics.
“Sometimes it takes a year, or two, or even three for the market to sort through the bad news. My guess is in three years, buying right now will turn out to be a terrific investment. In terms of my own personal investment portfolio, it’s probably one of the best times I’ve ever seen in my career to be buying small-cap growth stocks.
“Smaller caps tend to have higher short-term volatility than larger-cap stocks, and in time periods of uncertainty they tend to have the fastest declines. Small-cap stocks tend to have greater room for growth over a long period of time relative to more mature counterparts in the large-cap space. So companies that have greater growth opportunities are generally going to be valued at a premium as opposed to companies that are more mature. That premium tends to be much lower during uncertain times because no one knows then if they’re able to deliver the future cash flows that investors were banking on at the beginning.
“We look for companies that are creating unsettling change. These are companies that are growing at rapid rates and are moving to markets, or are either creating markets where they weren’t in before or are disrupting the market with innovation. We love to see companies in technology, the medical products area or in the pharmaceutical products area that are coming in and taking market share from their competitors via organic revenue growth. That tends to be indicative that our companies’ products are better than those of the competition or that there is no competition within that particular market.
“Natus Medical (Nasdaq:BABY) develops products for screening newborns and infants for medical disorders that may impede development during critical group months. The company's main product uses auditory brainstem response technology to enable simple, non-invasive screen for hearing impairment in newborns. The company has acquired or developed a number of additional products that are complementary and will offer significant growth opportunities. Revenues grew 32% in 2007 and are estimated to grow by 35% in 2008. EPS grew to $0.48 in 2007, up 33%, and are forecast to grow 40% in 2008.
“Phoenix Technologies Ltd. (Nasdaq:PTEC) develops BIOS (basic input/output systems) for computers. They have about a 50% global market share of all BIOS in the world. They have two new products being designed right now. One is a system to locate and shut down PCs that have been lost or stolen. Essentially, if you go somewhere with a notebook PC and the PC gets lost or stolen, they are able to locate and erase the hard drive and potentially recover the PC because it was connected with their GPS system. [The company is forecasted to swing to a profit in 2008, while revenues are estimated to grow by 50%.]
“Chryon (AMEX:CGS) develops products that enhance the presentation of live and pre-recorded audio and video. The company has strong demand and growth in its broadcast graphics business. Revenues grew 23% in 2007, but grew at much faster rates in the second half and appear to be accelerating. Pretax income was up 100% in 2007 versus 2006. The stock is a tiny microcap with little institutional following."
