12/28/98 LOOKING FOR GOLD? TRY DIGGING DEEPER

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LOOKING FOR GOLD? TRY DIGGING DEEPER
There's plenty of potential in companies too small for big investors to bother with

A 66-year-old name in home furnishings, Ethan Allen Interiors Inc. barely rang a bell on Wall Street a few years back. The retailer had a strong balance sheet, good earnings, and a sensible expansion plan, but its share price was stuck around $10. Few analysts covered the stock, and none spied much opportunity. Then, last year, everything started to click.
Earnings soared, and by last March the stock topped 66 before retreating to around 40 recently. So why did Ethan Allen go unnoticed for so long? Investors routinely get blinded by glamour stockS. ''Today, it's the romance of the Internet,'' says CEO M. Farooq Kathwari. Less exciting companies, meanwhile, may be well run and have close relationships with customers, ''but they don't get recognized.''
PROSPECTS. A sevenfold gain in any stock doesn't happen routinely. But for many investors, searching out the next Ethan Allen is what makes stock-picking intriguing. It's a way to beat the pros on a field tilted in their favor. Most megabuck portfolios ignore smaller-company stocks, since they can't buy enough of them to make a real performance difference. The upshot: less competition for the best small-company stocks at the right prices.
The risk is always that a stock ignored by Wall Street today will still be ignored tomorrow. Ultimately, though, strong earnings are hard to hide. With that in mind, we searched Morningstar Inc.'s Principia Pro database for U.S. companies with good returns on equity and strong balance sheets yet little or no Wall Street coverage. We looked only at companies trading at $5 or more a share and with market values of $50 million to $500 million and returns on equity of at least 15% in each of the past five years. To capture possible takeovers, one way small-stock investors are rewarded, we nixed any company with half or more of its shares closely held.
We came out with 13 companies, from which we settled on six with the best long-term growth prospects plus one high-dividend payer (table, page 122). Some, such as Electro Rent Corp., which rents PCs and testing equipment, may be undervalued. Others, including Techne Corp., a medical-products supplier, may rarely go cheap. All, however, are well-established businesses with solid prospects.
HOT NICHES. Comarco Inc., for example, has at least three sources of future growth, unusual in a company with $88 million in sales. Based in Yorba Linda, Calif., Comarco has branched out into wireless telecommunications from its roots as a provider of technical staff to the government and defense contractors. It has contracts in several states to install or upgrade roadside emergency call boxes, a niche it dominates. The company recently began to sell a patented universal power supply for laptop computers and cell phones. Perhaps its hottest niche is selling measurement tools to the cellular industry. They help the likes of Bell Atlantic Corp. monitor audio quality and billing accuracy. ''We see next year being much better than this year,'' says Chief Executive Don M. Bailey, whose goal is 25% compound growth in sales and earnings. One early Comarco investor was Wanger Asset Management. It has a 19% stake--and plans to stick with it, says portfolio manager Mark H. Yost.
Electro Rent hasn't fared as well lately. As PC prices have plummeted, the Van Nuys (Calif.) company has suffered lower rental rates and swifter depreciation on its inventory, which have snapped a long string of higher profits. In the fiscal year ended last May, Electro Rent earned $1.33 a share. CEO Daniel Greenberg says he'll be happy this year to net even the 90 cents a share estimated by T. Rowe Price portfolio manager Preston G. Athey, a longtime Electro Rent holder. The bright side is that the PC price plunge seems to be stabilizing, and the company is making progress folding in the acquisition it made a year ago of its chief rival, a unit of GE Capital Corp. Even with lower earnings, Electro Rent proved its ability to spin out cash by generating enough to pay off $80 million of its $252 million in bank debt after the merger. That cut interest expenses to an annual rate of $9.6 million from $16.8 million. Those savings will go straight to the bottom line.
In Mankato, Minn., little Hickory Tech Corp. celebrated its centennial this year. But emboldened by telecom deregulation, this phone company is leaving its past behind. It has made some acquisitions and is expanding into cell phones and providing billing for other phone companies. It's also extending into adjacent communities, where it believes it can compete well against larger rivals such as U S West Inc. Over the past five years, Hickory Tech's revenues and profits have surged. Chief Financial Officer David A. Christensen says Hickory aims to double its $88 million in sales over the next five years. Hickory's strategy has some risks--new investments may slow growth in profits and its 44 cents dividend. But, Christensen maintains, ''we are changing into a growth stock, and not just a dividend-paying entity.''
NEW BAG. Liqui-Box Corp. makes plastic packages for milk and spring water. Now, with a new line known as a ''form-fill-seal'' bag, the Worthington (Ohio) company hopes to grab market share from can and bottle makers for soup, sauces, juices, and sports drinks. The bag is sturdy enough to stand upright, says President C. William McBee, and can be formed, filled, and sealed aseptically by one machine. McBee says one risk for the company, with annual sales of just $157 million, is being a small player amid huge rivals and customers such as Perrier Group of America. Another is thin trading in the shares--a concern with any little-known stock. We checked the market one day and found a gaping $1.50 spread between what you would have paid for the stock one minute and how much you would have gotten for it the next.
Techne, by contrast, had a 25 cents trading gap, the narrowest of this group. It thrives in two biomedical niches: sales of controls and calibrators that help hematology labs perform blood tests and, more profitably, cytokines, which are protein molecules in growing demand by biotechnology researchers. In July, Techne moved to dominate the cytokine market by taking over its chief competitor, a unit of Genzyme Corp. With amortization charges from the deal, CEO Thomas E. Oland initially figured this year's earnings would sink by up to 12 cents a share. But orders are strong enough that he now sees net income in fiscal 1999, ending June 30, running flat. Beyond that, he expects strong growth.
A slower but steadier grower is Tompkins County Trustco Inc., which runs a 162-year-old bank in Ithaca, N.Y. The steady payroll at the area's largest employer, Cornell University, has long kept the local economy, and the bank, on an even keel. For its future, the company is counting on a key distinction that has helped it expand its share of the area's deposits to more than 40% from about 25% seven years ago: ''We are the only independent commercial bank in the area--and that's unlikely to change,'' says Chief Financial Officer Richard D. Farr. Loans through September grew 7%; earnings advanced nearly 12%. The bank is well capitalized, with more than twice what's required, and it steadily boosts its dividend by about 10% a year, a custom Farr doesn't see dying.
''VERY SAFE.'' A nice dividend is even more important to investors in United Mobile Homes Inc., an Eatontown (N.J.) real estate investment trust. It recently yielded a relatively high 7.5%. Its 24 mobile home parks are older and of relatively low quality, according to Winsor ''Skip'' Aylesworth, manager of FBR Realty Growth Fund, a sometime UMH investor. Still, Aylesworth thinks Chairman Eugene W. Landy and his son, Samuel, who is president, know the business thoroughly and do a good job at the low end of the market. ''This is a very safe, stable income stream,'' Aylesworth adds.
Sam Landy sees 1999 revenues growing by 7%, with funds from operations and the dividend climbing about 10%, as the company follows its five-year plan to go from 5,600 to 7,500 sites. Landy estimates the shares recently traded at just 60% of the company's asset value. That's cheap by anyone's book--as are many other underappreciated gems. Blue-chip stocks may be sky-high, but there's no dearth of businesses that are solid, growing, and potentially rewarding to anyone willing to pay attention.
By Robert Barker

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