July 2008 Roundtable Part 3

As the credit crisis has enraptured equities valuations have been squashed on stocks good and bad. Translation: valuations on financially healthy companies are attractive at current levels. However, that’s not to say that there isn’t earnings risk with higher commodity prices eating away at margins of companies in many sectors and further possible reductions in earnings estimates.

Our panel also explores the perils of inflation, stagflation, the beleaguered greenback and the presidential election’s effect on small cap equities. Lastly our experts take a look at possible share dilution and buybacks in an environment that’s shown varying degrees of illiquidity. (This is part three of a five part series.)

How are valuations on small caps now across the board?

Lisanti: “They’re cheap. When you look at the Russell 2000 growth, it’s selling at about one times its growth rate, which is very low. The Russell growth is selling at about 20-times its earnings and is supposed to grow at 19% going forward. Stuff in our portfolio is selling at about half its growth rate. We’re basically with companies that are growing about 45% and we’re paying about 22-times earnings for them. That’s really cheap. They have to overcome these economic headwinds and if they do, then the stocks will go up. But economic headwinds are not monolithic, sometimes they can prove to be positive. 

“My guess is they’re probably underweight small-cap growth and overweight small-cap value.” 

Oberweis: “Valuations are still substantially below what we typically see for high-growth equities. To be quantitative, we track the average P/E of companies that are growing in excess of 30% with a market capitalization of less than $1 billion. There are typically about 600 constituents in that group. It’s not a perfect statistical indicator, but it gives us a very good sample of where valuations have been and are going.

“Based on the standard forward estimates, the average P/E within that universe is about 23. Based on historical reported numbers, the average P/E within that universe is 33. To put it into perspective, the average historical over the last, say, five years based on forward is 30 and based on historical is 36. We’re well below average. The low we saw at the end of March was 21.7 based on forward. Based on . . .

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