Wyatt's Winners: 20/20 Growth

05/28/2004 12:00 am EST


Ian Wyatt

Publisher & Chief Investment Strategist, Wyatt Investment Research

Although he covers a broad range of small cap growth stocks in his Growth Report, editor Ian Wyatt has a knack for finding exciting tech opportunities, particulary in the Internet and communications arenas. Here, he discusses his strategy and some current favorites.

"We focus on small cap growth stocks with a focus on historical and projected earnings and revenue growth as core factors for picking top performing stocks. We take a long-term approach to investing in growing businesses and focus on fundamentally strong companies. We are not sector driven; rather, we take a bottom up approach to investing. Our aim is to pick high growth companies ahead of Wall Street and Main Street. We seek unknown growth companies provide the greatest upside potential for early investors. The stock market is designed to effectively set prices on shares of stock based on information available to the public. Small caps are the exception. The beauty of small caps is that information is not widely known and that diligent research can breed substantial results unobtainable in other sectors of the market. In addition, small companies can grow faster: it is much easier to grow from $50 million to $100 million in revenues than it is from $1 billion to $2 billion.

"Our requirement for stocks is what we call 20/20 growth. The companies we recommend must grow revenues and earnings at +20%. In addition, they must have a proven management team and sales growth should be driven organically, and not primarily through acquisitions. In terms of valuation, we look for a PEG rate - or p/e to growth rate - of less than 1, preferably under 0.50. The red flags we look for to sell a position is when a company misses previously stated guidance. Another red flag is a decline in a company's sales or earnings, or a dramatic decline in quarter-over-quarter growth rates. We would also be cautious if we see a company loss a major client or contract, or if the firm is predicting business difficulties on an ongoing basis. We would note that we rarely sell on price appreciation alone

"We believe the current market is a still a good environment for buying small cap stocks. Small caps led the stock market higher in 2003, but are off to a difficult start in 2004. Small caps typically rise dramatically in the early stages of an economic recovery. We believe in the long-term growth of small caps which have historically outperformed the S&P 500 by 2% each year. While investing in small caps has become more difficult, we believe the losses thus far in 2004 will be short lived. The decline in small cap stocks should be viewed as a buying opportunity, not a reason to sell. Indeed, the fundamentals of many small caps are stronger today than a year ago and there has been a significant increase in financial results. Small caps are down across the board, creating wonderful opportunities from a valuation prospective. In our opinion, investors who buck the trend by going long when everyone is selling should be rewarded nicely.Our conclusion is that while small caps have been volatile in 2004, but many opportunities are available from both a growth prospective and based on valuations. Meanwhile, here are five favorite growth stocks for today’s market:

"J2 Global Communications (JCOM NASDAQ) is a communications company whose primary product is eFax, which is a subscription service that allows users to receive faxes directly to their e-mail. The firm has over 6.3 million subscribed phone numbers (free and paid). In 2003, revenues increased by 49% to $71.6 million and the company earned $1.42 per share, pre-tax. 2004 guidance calls for revenues of $100 - $105 million, a 43%; gain and pre-tax earnings of $1.65 - $1.75, up 20%.

"Sonic Solutions (SNIC NASDAQ) makes DVD-authoring software, and sells direct and through OEM partners. It has new relationship with Dell, who contributed 20% of revenues in the first quarter. In what we view as a win-win relationship Sonic Solutions gives away a free version with every Dell computer order, and then up-sells better versions. Fiscal 2004 guidance calls for revenues to rise 73%, with net income of $11 million, or $0.46 per share. Management recently raised guidance for 2005 and expects 50% revenue growth, and 63% earnings growth

"INVESTools (IED ASE) provides investor education products including courses and subscription services to individuals. It has exclusive partnerships with Business Week, CNBC, and the Motley Fool. We see the opportunity for the company to grow revenue per customer, build-out new partnerships, and grow number of workshops. Revenues for 2003 rose 31% to $73.4 million, while fourth quarter revenues were up 51%. We believe the shares are cheap compared with its peer group of education and financial content companies. It also trades at a discount based on enterprise value to sales.

"PetMeds Express (PETS NASDAQ) sells pet medications through direct sales channels, such as the Internet and TV infomercials. PetMed is the clear leader in the market, competing mainly with small vet clinics. Nine-month results show a revenue gain of 81%, with net income of $0.19 per share. Fourth quarter earnings of $0.11 gives full year earnings of $0.30, putting the stock at 33-times our fiscal 2004 earnings per share estimate.

"The Knot (KNOT Other OTC) is a leading wedding media company with print and online resources. In 2002, The Knot signed up 1.1 million users, commanding 60% of this market. The firm generates revenue through on-line advertising, local and national print advertising, and a growing merchandise business. We expect 2004 revenue and earnings growth of 25%. The shares, at $3.50, are a bargain. The stock should increase both on strong financial results and more attention from investors."

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