Over-the-counter stocks still lack oomph
New York — If investors sponsored police shows, the Dow industrials would be decked out in silk suits, tooling around in a Ferrari. The over-the-counter NASDAQ industrials would be a band of Texas Rangers in grubby 10-gallon hats and a battered truck. In the last month, the Dow raced ahead of secondary stocks - rising twice as fast. Indeed, last week the Dow Jones industrial average broke the record high set April 5 and closed at 2,420.85 on Friday. In five trading sessions, the Dow picked up 43.12 points.
The NASDAQ averages, by contrast, are well below highs set earlier this year.
``There's just not as much buying interest in small stocks,'' says Maneck Kotwal, a technical analyst at Smith Barney, Harris Upham & Co. ``On a valuation basis, the secondaries look good. But it's premature to buy these stocks on a momentum basis.''
Robert Chesek agrees. ``The lack of action, the lack of liquidity in OTC [over-the-counter] stocks can be a real stinker,'' says the manager of the $125 million Phoenix Stock Fund, a subsidiary of Phoenix Mutual Life Insurance Co. of Hartford, Conn.
The dearth of buyers makes it difficult to profit even on good news. Mr. Chesek has seen several companies report surprisingly positive earnings. ``But you don't get the same upside response [in the stock's price] that you see in the large-cap issues. And if you get a poor earnings report, the stocks get whacked.''
Being listed on the New York Stock Exchange didn't protect several brokerages from getting ``whacked'' last week. Both Salomon Brothers and First Boston reported taking big bond-trading losses in April and May. Last month, Merrill Lynch reported a $275 million trading loss. Other brokerages got through the quarter relatively unscathed, anlaysts say.
Chesek isn't enamored of brokerage stocks, but he does like computer stocks, even if they're OTC issues. He is now buying Apple Computer, which is his second largest holding. ``With IBM's new products, the PC business is in a state of flux. I think that creates an opportunity for Apple and other PC makers.''
But for the most part, Chesek is holding back on NASDAQ issues, waiting for the summer rally to broaden. Don't wait too long, advises Glenn Cutler, editor of the investment newsletters Market Mania and Red Herring in Pacifica, Calif. The over-the-hill gang may be on the verge of a comeback.
``From January through March the over-the-counter market outran all other markets,'' Mr. Cutler says. ``So, it's going through a longer consolidation period. I believe that period is close to over. And there are some great stocks selling at extremely low multiples now.''
One of Cutler's cut-rate darlings: BHA Group. This Kansas City pollution control company has chalked up a five-year growth rate of 57 percent. It's selling at about $10 a share. ``You can pay 12 times earnings for a company with that kind of growth rate, operating in an industry that generally sells at higher than market multiples,'' says Cutler.
The quality and pricing of initial public offerings have also improved as the OTC market has cooled. ``There are better opportunities for the public now,'' notes Cutler.
The biggest offering slated, E-II Holdings, will be sold late this month. ``This could the most controversial go-go stock of the late bull market,'' says Robert Natale of Standard & Poor's New Issues newsletter.
E-II is the old Esmark, bought by Beatrice Corporation, which was then taken private in a leveraged buyout. Most of about $600 million raised in the stock offering will pay off the buyout principals. E-II, Mr. Natale says, ``has very little in the way of sales and earnings growth. Investors will be buying in at the leading edge of risk at this late stage in the bull market and the economic expansion.''
But there's a kicker. E-II is also making a $1.5 billion debt offering to be used for acquisitions. And E-II's head, Donald Kelly, has an impressive buying record.