Good Times Ahead For Small-Cap Stock?

IT'S time to think ``small-cap'' stocks, says William Martindale Jr. Mr. Martindale is managing principal of equities for Martindale, Andres & Godshalk, an investment firm with $60 million under management, based in West Conshohocken, Pa., outside Philadelphia. The firm, about two years old, develops investment strategies for ``high-worth'' individuals and small pension plans.

Investment strategies for these clients could involve buying both bonds (such as Treasury issues) and smaller-capitalization stocks, which are companies with a net worth above $50 million, or below $1 billion. Martindale particularly likes companies valued between $500 million and $1 billion.

Most importantly, Martindale believes in not only buying, but hanging on to small-cap stocks - say at least two or three years. Since the beginning of this year, small-cap stocks have helped fuel much of the momentum in the market, although they made a modest retreat last month. But small-cap enthusiasts aren't grousing: after all, the 1980s, by and large, weren't altogether happy years for them. The Reagan-decade favored giant companies (often heavily leveraged) that produced high rates of return.

Now, the economic climate has changed, says Martindale: in a ``slow-growth economy'' like now its going to be ``very difficult for big [blue-chip] companies to provide high rates of return.'' The upshot, he says, is that the current economic environment will help smaller companies that are not heavily leveraged, have solid market-niches, and build their success over a number of years.

Time will tell whether Martindale is right. Over the last 50 years, small-cap stocks have done well, even outperforming the Standard & Poor's 500 index, as noted in a recent examination of comparative investments in Barron's, a national financial weekly. But for shorter periods of time, small-cap stocks have often been volatile, turning in negative results during some periods.

Sandip Bhagat, who is assistant vice president and a portfolio manager with TIMCO, based in Hartford, Conn., believes that the best climate for small-cap stocks may not come until later this year - say, around October - when the nation will presumably begin to lift out of recession. (TIMCO is the investment management arm of Travelers Corporation, an insurance company.)

Mr. Bhagat notes that while small-cap stocks are relatively inexpensive, they are still not doing as well as large-cap issues in terms of relative earnings. He believes that anyone contemplating buying small-cap stocks should be doing so on a dollar-averaging basis - that is, committing a small part of one's total investment (10 percent to 15 percent) on a monthly basis, while waiting until later in the year for any major buying of small cap firms.

Bhagat, and Martindale, both small-cap watchers, start with completely different investment premises. However, in some respects they come out at the same place in terms of buying. Martindale also recommends investing slowly in a company, similar to dollar averaging.

In terms of overall strategy, Mr. Bhagat is a ``top-down'' strategist; he looks at specific economic sectors or types of stocks. Martindale is a ``bottom-up'' strategist; he starts with specific companies. He looks at a company's balance-sheet, its management, and its market-niche.

Currently, Martindale's portfolio consists of some 30 companies. Among small-cap issues that he likes: Raven Industries, a ``mini-conglomerate'' on the American Stock Exchange that produces military clothing and electrical equipment for farms. Martindale believes Raven will soon be doing about $100 million annually in sales. Another issue, Farr Company, is listed over-the-counter; Farr makes filters for industry.

Before setting up his own firm, Martindale was first vice president of the financial investment group for Dean Witter Reynolds. He is now looking for small-cap companies with European ties, as that continent moves toward economic unification.