Optimism from Oberweis

08/20/2004 12:00 am EST

Focus:

James Oberweis

Editor, The Oberweis Report

Jim D. Oberweis, editor ofThe Oberweis Report, is one of the leading authorities on small cap investing. He looks for "turbo-charged" firms growing at 30%+ per yearyet trading at a p/e that is less than half of its growth rate. Here are some that make the grade.

"To assess the current market, I think we have to keep in mind the overall background of where we are coming from. In the fourth quarter of last year, the US had the strongest GDP growth of any quarter in almost 20 years and with continued solid growth this year, the economy in the United States is in pretty good shape. In addition, look at what’s going on in the world. The IMF estimates that the years 2004 and 2005 will be the best two-year period of GDP growth in the world economy in over a quarter of a century. We’ve got a pretty good overall environment. We have strong economies in China and India. Even Japan is coming alive again. And some of the Eastern European countries are doing well, which will help increase world demand for US manufactured goods as well. The overall economic picture is pretty good.

"We have extraordinarily low interest rates, which will go up considerably from here. I believe we’ve seen a major upturn in interest rates. There will be some political pressure to keep them under control, but when we get into 2005, I think we are going to see much higher rates I mean 200 to 300 basis points over the 2005-2006 period in intermediate and long-term rates. Nevertheless, this will be coupled with a strong economy. We also have to look at valuations in the stock market. Valuations were obviously incredibly high in the late 1990s. They then went to fairly low points in 2002. Had a huge rally last year, but this year we’ve seen a significant correction in two ways. Earnings have risen significantly to reduce p/e multiples and prices have reduced p/e multiples the other way, by coming down. So p/e multiples have gone from pretty high levels earlier this year to more modest levels. I wouldn’t call them cheap, but they are average or below average, making the overall investment climate reasonably attractive. The last thing we need to make it really attractive is to have a real nasty sell off and have everyone saying, ‘Get me out. I don’t want to be in stocks anymore.’ We’re not quite there, but in some ways we are getting close. We are definitely seeing fear taking over from greed. I think that’s a very positive thing.

"Meanwhile, our investment approach hasn’t changed one iota in 20 years. We have three fundamental objectives. A company must be growing revenues at 30% or faster. So these are turbo-charged companies. They must be prosperous and growing earnings at 30% of better rate. And they must be cheap in relation to their rate of growth. The p/e can’t be greater than half the rate of growth, so a company growing at 50% a year, has to have a p/e multiple of 25 or less. Having said that, our portfolio of all three of our funds has an average growth rate of revenues and earnings in excess of 50% and the p/e to growth rate has now dropped back thanks to the decline in the market to some of the lower values we’ve seen in quite awhile.

"There is a company called Connetics (CNCT NASDAQ) in the dermatology area that is showing exceptional growth rates. It’s a perfect example of the type of investment philosophy that we use. Earnings are growing very rapidly. Revenues are growing very rapidly. The p/e is low in relation to growth and the icing on the cake is that they have two additional products in the acne solution area that are about to be approved by the FDA. They are in the final stages of testing. When those are approvedand we think that will happen in a matter of months that should help to assure consistent, significant additional growth for the next couple of years.

"I think that certain areas such as gold mining or oil and gas are probably reasonable investment sectors. I believe the market is pricing in oil and gas stocks based on a value for oil of something in the $25 to $30 per barrel range. It is possible that oil will drop back to that range, but it’s also possible it won’t. If oil remains in the $35 to $45 range, I believe that most of the oil and natural gas stocks are extremely attractive at their current valuations. One I'd mention is a small company, Carrizo Oil & Gas (CRZO NASDAQ), which is run by a gentleman with 15 years of experience at Shell. It’s a very low-cost operation. Most of their production is on-shore in the United States. They take some marginal wells, operate them with very low costs and they are able to produce very good returns. If oil and gas stay in the current area, I think we will see huge increases in both revenues and earnings over the next couple of years."

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