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HOT GROWTH COMPANIES

They're smart, they're agile--and they're piling up earnings. Meet the stars of the small-cap set

Gradall Industries Inc. may not fit your idea of a typical hot-growth company. For starters, the New Philadelphia (Ohio) company was founded more than 50 years ago. And while many small-cap wonders soar by riding the latest high-tech wave, Gradall sells giant earthmovers and other equipment used in highway construction and on building sites.

In the early 1980s, Gradall was well on its way to becoming just another Rust Belt relic. Spun off from AlliedSignal Inc. in a 1983 leveraged buyout, Gradall had withered as a result of meager investment in new products. And intense competition from the Japanese cut profits. When a band of former International Harvester Co. executives took over in 1985, they named ex-Harvester manufacturing executive Barry Phillips president. He improved the quality of Gradall's existing machines and began pumping millions into new product development. ''The opportunity was always here,'' says Phillips, who became CEO in 1995. ''Somebody just had to work hard enough to make it happen.''

The hard work has certainly paid off. Earnings at Gradall have skyrocketed an average of 113% annually, to $8.3 million, over the past three years, while return on capital has averaged a stunning 72.7%. And steady sales growth has topped 25% annually, to hit $141 million. The dynamic mix of fast growth and red-hot profits was enough to earn Gradall the No.11 spot on BUSINESS WEEK's 1997 list of the 100 fastest-growing small companies.

That combination of drive, ingenuity, and agility marks all the companies on BUSINESS WEEK's 1997 Hot Growth list. It also keeps them charging ahead faster than much bigger rivals. Sure, many giants of Corporate America continue to boast impressive gains. But these tiny dynamos still put them to shame. For the past three years, the 100 companies saw average annual sales growth of 57.2%, vs. 8.21% for the Standard & Poor's Industrial index. Earnings grew 133%, vs. 22.38% for the S&P, while return on capital hit 32.5%, vs. 12.2%.

NICE NICHES. Unlike Gradall, many of these supercharged superstars are cashing in on the high-tech revolution. Software, computer, and telecom companies alone hogged 41 spots. ''Any company that helps you use information and knowledge efficiently will be hot,'' says Thomas L. Doorley III, senior partner at Boston-based consultants Braxton Associates, which develops growth strategies.

That includes No.1 Yurie Systems Inc., which sells equipment that allows for the speedy transmission of video, voice, and data over satellite and phone links. Vitech America Inc. (No.2) manufactures PCs in the north Brazilian town of Ilheus, selling many direct to local buyers. And i2 Technologies (No.8) makes prepackaged software that aids supply-chain management.

Other small companies are capitalizing on Corporate America's drive to outsource. General Employment Enterprises (No.15) provides computer and networking workers for the financial-services and software industries, while Data Processing Resources Corp. (No.16) does similar staffing for the health-care, auto, and entertainment industries. Health care--along with services geared to the aging U.S. population--also proved lucrative. Chad Therapeutics Inc. (No. 32) makes portable oxygen units, while Help at Home Inc. (No.39) provides home assistance to the elderly.

Yet mining a hot trend isn't the only route to success. Others have found lucrative niches following only their entrepreneurial instincts. Firearms Training Systems (No.6) provides systems for use by the military and law-enforcement agencies that simulate battlefield action or dangerous street arrests. And Apex PC Solutions Inc. (No.3) makes cabinets that help network managers organize their computers.

Still, buyer beware: Although many thrived operationally last year, small-companies--including many Hot Growth stars--saw their shares hammered. Growth stocks slid deeply last summer; tech shares in particular nosedived as Wall Street worried about rich valuations and the impact of a slowing economy. Says John W. Ballen, portfolio manager of MFS Emerging Growth Fund: ''1996 was a disaster if you focused on small growth companies.''

To cut risks, investors poured money into large companies, which were generating surprisingly strong earnings. The combination has made blue-chip stocks a better investment than small caps--and given small-cap investors a jolting roller-coaster ride. It wasn't until January that the Russell 2000 small-cap index made up for its summer losses--then it promptly plunged again in February when interest rates rose. Altogether, the S&P 500 has rung up a 25% gain over the past 12 months, while the Russell 2000 is up just 2%. Even many Hot Growth companies whose sales and earnings sparkled lagged. Stocks on this year's list traded at an average of 64.3% of their 52-week highs, while the S&P 500 is near its 52-week high.

The small-cap correction also put the brakes on the once sizzling market for IPOs. According to S&P, $49.2 billion was raised last year in the IPO market, well above 1995's $31.1 billion. But the pace has fallen off, with only $7 billion raised through April. But so far, venture capitalists haven't fled: Last year, a record $6 billion in venture funding was raised.

Despite the disastrous 1996, some believe small caps may rebound. ''We've already felt the bulk of the pain,'' says Jack H. Laporte, manager of T. Rowe Price's New Horizons Fund. A capital-gains tax cut looks likely, which could give growth stocks a boost. If the U.S. dollar remains strong, earnings at larger companies could be hit; small fry are generally less affected by exchange rates. And should the U.S. economy slow, growth stocks may regain Wall Street's favor.

Of course, even if the market picks up, there's always the risk of a fall for these dynamos (page 104). Some may stumble trying keep up the growth, while others may remain too tied to one trendy product. And for investors, there's the added risk of picking highfliers while Wall Street shuns such stocks. But for those able to ford these difficult streams, potential rewards are high as well.

By Amy Barrett in Washington



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Updated June 15, 1997 by bwwebmaster
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