Lots Of Room Left In Rally For Small Growth Stocks

Worries about the lofty levels of the stock market aren’t deterring bulls on small growth stocks as they look ahead to 1996.

Money managers who invest in “emerging growth” companies say the evidence doesn’t show any wide-spread excesses of enthusiasm for these newer, smaller enterprises.

If past patterns are any guide, they contend, there could be several years left to run in the small-stock rally that began at the start of the 1990s, after a long, lean spell in the ‘80s.

“We’re somewhere around the fifth inning of a nine-inning ball game,” says Eugene Sit, chairman and chief executive of the Sit Mutual Fund Group in Minneapolis.

“We believe that the U.S. economy is well positioned for sustained growth and low inflation, which should be a good environment for investment in equities,” say Lawrence Auriana and Hans Utsch, chairman and president of the Kaufman Fund, a “small company aggressive growth” fund in New York.

Sit acknowledged in an interview that stocks of all sizes will probably be hard pressed to keep up the pace they have set lately.

Through the first half of the 1990s, small company growth funds, as tracked by Morningstar Inc., have rung up average annual returns of about 22 percent.

But Sit projects that small stocks, propelled by their superior earnings growth, can achieve returns of 10 percent to 12 percent a year, while large stocks might settle for something closer to 8 percent.

That still represents good money compounded over time, he adds, especially when you consider that inflation is running at less than 3 percent.

Sit argues that the stocks in his Sit Small Cap Growth Fund don’t appear overpriced when you look at their projected earnings growth over the next five years of better than 24 percent a year, compared to their current price-earnings ratio of 19.4 to 1 based on estimated 1996 earnings.

Similarly calculated, the Standard & Poor’s 500-stock composite index has projected earnings growth of 12 percent and a P-E of 15.6 to 1.

Using Sit’s math, the small stock P-E is about 25 percent higher than that of the market as a whole, while the sector’s earnings-growth prospects are about double the market’s.

Past tops in small-stock bull markets have occurred with the P-E premium closer to 100 percent than the present 25 percent.

Sit also argues that the current and prospective economic climate favors growth stocks over cyclical companies, since the overall rate of profit growth in the United States seem to be slowing along with the economy.

Sluggish periods for the economy are considered favorable to stocks of companies whose earnings growth depends mainly on their own momentum, rather than on improving economy-wide conditions.

Sit acknowledges that prices of many technology stocks look steep, but says he is still an enthusiastic “selective” fan of technology investments. Beyond any questions of investment fads, he says, technology is playing a central part in a worldwide drive by businesses to improve their productivity and competitiveness.