Friday August 3, 12:49 pm Eastern Time
Slowing economy hits small company profits hardest
By Thi Nguyen
NEW YORK, August 3 (Reuters) -- When things fall apart, they fall apart faster for small companies.
As the U.S. economy slows, profits at small companies are hit faster and harder than earnings at large companies, said analysts
and money managers.
``The primary reason is estimates for small companies are dramatically affected when numbers of orders are pushed back,''
said Ken Perkins, an analyst at market research firm Thomson Financial/First Call. ``It's a big deal when a small company
misses a couple of orders. Sometimes it could cut their earnings in half.''
Wall Street analysts have reduced earnings estimates for small companies to declines of 12 percent and 17 percent for the
second and third quarters, from a rosy 10.6 percent growth forecast for both quarters in early April, First Call said. Estimates
for large cap companies have come down too, but only by half as much.
``By nature, small companies are more volatile,'' said Franklin Morton, director of research at Chicago-based Ariel Capital
which has $6 billion in small- and mid-cap stocks. ``In good times, earnings for small companies go up faster, but in bad times,
they come down faster.''
That spells trouble for one of the few bright spots in the market. So far this year, small-cap stocks lead the market with a 0.98
percent gain in the Russell 2000 index (^RUT - news), compared with declines of 7.52 percent and 15.67 percent in the S&P
500 and the Nasdaq composite index (^IXIC - news), respectively.
But as many investors choose to look past earnings this year and focus on next year's expected economic rebound, they
continue to love small company shares. If the economy turns around, small companies will rise faster than large firms, money
managers said.
``At this point, people are looking to the economic cycle,'' said Larry Baumgartner, portfolio manager with the One Group
Small Cap Value Fund who oversees $320 million in stocks. ``Earnings in 2001 will be poor but it's irrelevant. 2002 is what
matters.''
Indeed, investors have written off this year and look toward the next for a recovery. Analysts expect profits of small companies
will grow 30.9 percent in 2002, much faster than the expected 20-percent growth for large firms.
``That's typical of corporate growth coming out of the bottom,'' said One Group's Baumgartner.
Corporate earning growth under normal economic periods is 7-10 percent with no difference for small and large companies
over time, he said. Historically, small companies outperform large firms for a couple of years coming out of an economic
downturn, he added.
SKEPTICS QUESTION GROWTH OUTLOOK
There are skeptics.
A 30 percent growth ``obviously will never happen,'' said Steven DeSanctis, small cap strategist at Prudential Securities. "This
year they also estimated a 30 percent growth -- now, it obviously will be negative.
What a difference four months make. Analysts in April expected small-company earnings would outpace large-company profits
in the third quarter. Now the situation is reversed.
``Given the economy, it's not a surprise that their estimates come down so fast,'' said Morton. ``Many small companies have
just been around for less than 10 years, particularly technology companies. They are going through recession for the first time
and they don't know how to manage.''
The ratio of positive to negative earning revisions in the Russell 2000 small-cap index has deteriorated sharply, with two
negative revisions to each positive one, said Bill Julian, small cap strategist at Salomon Smith Barney.
It's been this bad only twice in the past 15 years -- in 1990 and 1998. In both cases, the Russell 2000 had already bottomed
or was within one month of the bottom and it was 35 percent higher 12 months later, said Julian.
``It appears that once the revisions ratio drops from a high to below 0.5, it signals a level of pessimism that can support a rally
thereafter,'' said Julian, who expects to see a sustained rally in the index within the next three months.
Gruß Dr. Broemme
Slowing economy hits small company profits hardest
By Thi Nguyen
NEW YORK, August 3 (Reuters) -- When things fall apart, they fall apart faster for small companies.
As the U.S. economy slows, profits at small companies are hit faster and harder than earnings at large companies, said analysts
and money managers.
``The primary reason is estimates for small companies are dramatically affected when numbers of orders are pushed back,''
said Ken Perkins, an analyst at market research firm Thomson Financial/First Call. ``It's a big deal when a small company
misses a couple of orders. Sometimes it could cut their earnings in half.''
Wall Street analysts have reduced earnings estimates for small companies to declines of 12 percent and 17 percent for the
second and third quarters, from a rosy 10.6 percent growth forecast for both quarters in early April, First Call said. Estimates
for large cap companies have come down too, but only by half as much.
``By nature, small companies are more volatile,'' said Franklin Morton, director of research at Chicago-based Ariel Capital
which has $6 billion in small- and mid-cap stocks. ``In good times, earnings for small companies go up faster, but in bad times,
they come down faster.''
That spells trouble for one of the few bright spots in the market. So far this year, small-cap stocks lead the market with a 0.98
percent gain in the Russell 2000 index (^RUT - news), compared with declines of 7.52 percent and 15.67 percent in the S&P
500 and the Nasdaq composite index (^IXIC - news), respectively.
But as many investors choose to look past earnings this year and focus on next year's expected economic rebound, they
continue to love small company shares. If the economy turns around, small companies will rise faster than large firms, money
managers said.
``At this point, people are looking to the economic cycle,'' said Larry Baumgartner, portfolio manager with the One Group
Small Cap Value Fund who oversees $320 million in stocks. ``Earnings in 2001 will be poor but it's irrelevant. 2002 is what
matters.''
Indeed, investors have written off this year and look toward the next for a recovery. Analysts expect profits of small companies
will grow 30.9 percent in 2002, much faster than the expected 20-percent growth for large firms.
``That's typical of corporate growth coming out of the bottom,'' said One Group's Baumgartner.
Corporate earning growth under normal economic periods is 7-10 percent with no difference for small and large companies
over time, he said. Historically, small companies outperform large firms for a couple of years coming out of an economic
downturn, he added.
SKEPTICS QUESTION GROWTH OUTLOOK
There are skeptics.
A 30 percent growth ``obviously will never happen,'' said Steven DeSanctis, small cap strategist at Prudential Securities. "This
year they also estimated a 30 percent growth -- now, it obviously will be negative.
What a difference four months make. Analysts in April expected small-company earnings would outpace large-company profits
in the third quarter. Now the situation is reversed.
``Given the economy, it's not a surprise that their estimates come down so fast,'' said Morton. ``Many small companies have
just been around for less than 10 years, particularly technology companies. They are going through recession for the first time
and they don't know how to manage.''
The ratio of positive to negative earning revisions in the Russell 2000 small-cap index has deteriorated sharply, with two
negative revisions to each positive one, said Bill Julian, small cap strategist at Salomon Smith Barney.
It's been this bad only twice in the past 15 years -- in 1990 and 1998. In both cases, the Russell 2000 had already bottomed
or was within one month of the bottom and it was 35 percent higher 12 months later, said Julian.
``It appears that once the revisions ratio drops from a high to below 0.5, it signals a level of pessimism that can support a rally
thereafter,'' said Julian, who expects to see a sustained rally in the index within the next three months.
Gruß Dr. Broemme
