Markets & Finance

Stock Screen: Small-Cap Momentum Plays


S&P's newest list finds 27 names that score well in terms of relative strength—and earn top ratings from its analysts

From Standard & Poor's Equity ResearchFrom Standard & Poor's investing newsletter The Outlook

In the recent market turbulence, small-cap stocks, as a group, were harder hit than their larger-cap brethren, as investors sought the safety of the bigger names. But Standard & Poor's maintains small-cap stocks should belong in a well-diversified portfolio.

To that end, S&P's investing newsletter The Outlook screened for small-cap stocks with investment rankings of 4 STARS (buy) or 5 STARS (stong buy) from S&P equity analysts that land in the top half of S&P's equity universe when sorted by relative strength. That's a measure of a stock's momentum—how it performs relative to the broader market over 4-week, 13-week, and 52-week periods. Savvy investors know to watch momentum for clues to stocks that are moving up and have the characteristics to realize further upside.

All the stocks that made the cut are in the table below. Here we spotlight three of the names:

Benchmark Electronics

This provider of electronics manufacturing services took in 58% of its 2006 sales from computers and related products, with the remainder coming from medical devices (13%), telecom equipment (12%), industrial control equipment (11%), and testing and measurement equipment (6%). We believe Sun Microsystems (JAVA) and EMC (EMC) together will represent more than 30% of Benchmark's (BHE) sales in the near term.

We expect Benchmark to outperform peers in a narrow-margin industry through its increasing focus on nontraditional markets, such as medical equipment, where it can exploit special expertise. The company typically carries no long-term debt, although it added some as a result of the January, 2007, acquisition of Pemstar, which provides outsourced engineering and design.

We expect Benchmark's overall revenue to rise 6% in 2007 and 11% in 2008. The operating margin should widen toward 5% in 2008, given the higher volumes we project. We estimate earnings of $1.63 a share for 2007 and $1.94 for 2008. Our 12-month target price of $31 applies a price-to-earnings ratio (p-e) of 17, which is near the midpoint of a five-year historical range, to our forward 12-month earnings estimate of $1.80.

Risks to our recommendation and target price include the loss of a major customer, delays associated with the implementation of new program wins, and problems with inventory management.

Manitowoc

We see revenues rising more than 30% in 2007, followed by a gain of about 15% in 2008. We look for the increases to come almost entirely from Manitowoc's (MTW) principal crane division, which we believe will benefit from healthy demand in foreign markets, expected ongoing strength in U.S. commercial construction activity, increased global distribution efforts, and new product introductions.

We expect the operating margin to expand in both 2007 and 2008, on the solid demand that we see for Manitowoc's cranes combined with the likely incremental benefits of previously implemented cost reductions. Our per-share earnings estimates are $2.48 for 2007 and $3 for 2008.

Manitowoc trades at about 13 times our 2008 estimate. That's in the middle of its typical range for the midpoint of business upturns, which is where we think we are. Based on the robust level of profit growth from the company in recent periods and our outlook for continued strong gains, we believe a valuation closer to the higher end of the company's traditional mid-cycle range is appropriate. Applying a p-e multiple of 17 to our 2008 forecast implies a value of $51, which is our target price.

Risks to our recommendation and target price include weakness in the global economy, which could lead to a downturn in commercial construction markets.

Sciele Pharma

We believe Sciele (SCRX) has achieved marked success through its strategy of acquiring drugs from large drugmakers and then increasing sales through aggressive marketing. Sciele, in our view, has carved out valuable franchises in growing cardiovascular, women's health, and other markets.

Recently, the Food & Drug Administration approved a filing for an improved formulation of Sular, an anti-hypertensive. Using a novel technology that allows for lower dosing, we think the new version should have a better side-effect profile than existing Sular. We think that Sciele should be able to switch customers to the new drug well before mid-2008, when generics are likely to erode original Sular sales. We see much promise in the acquisition of Alliant Pharmaceuticals, a maker of pediatric drugs.

We expect revenues to grow to about $450 million in 2008, from the $380 million we see for 2007. We look for sales of cardiovasculars to show solid growth, helped by the planned launch of an improved formulation of Sular, gains from Fortamet, an expanded sales force, and higher prices. The Zovirax herpes treatment should boost volume, as should the full-year contribution from Alliant. But we think sales of women's health products will be relatively flat, reflecting competitive pressures in the Prenate line, a vitamin for pregnant women. Our earnings estimate for 2008 is $1.90 a share, up from the $1.65 we project for 2007. Our 12-month target price of $31 applies a peer level p-e of about 16 to our 2008 earnings estimate.

Risks to our recommendation and target price include greater-than-expected competitive pressures in key lines.

RECOMMENDED SMALL-CAP STOCKS

Name

Ticker

S&P Stars

Ranking

S&P Quality

Ranking

Arris

ARRS

5

B-

Astec Industries

ASTE

4

B-

Benchmark Electronics

BHE

4

B

Chattem

CHTT

4

B

Clarcor

CLC

4

A

DJO

DJO

4

NR

East West Bancorp

EWBC

4

A

Energen

EGN

4

A

Essex Property Trust

ESS

4

A-

Gibraltar Industries

ROCK

4

B+

Great Atlantic & Pacific Tea

GAP

4

C

Helix Energy Solutions

HLX

4

B

Hologic

HOLX

5

B-

Kirby

KEX

4

B+

Longs Drug Stores

LDG

4

B+

Manitowoc

MTW

5

B

Mantech International

MANT

4

NR

National Retail Properties

NNN

4

B+

Old Dominion Freight Line

ODFL

4

B+

Regeneron Pharma.

REGN

4

C

Ruth's Chris Steak House

RUTH

4

NR

Sciele Pharma

SCRX

4

NR

Toro

TTC

4

A

Triumph Group

TGI

4

B-

UGI

UGI

4

A

URS

URS

4

B

Waste Connections

WCN

4

B


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