The Stock Pickers' Ball

Experts pick their favorite Inc. 100 stocks and offer some investment advice.

By Stephanie L. Gruner | 
 

Where on the Inc. 100 list does the smart money go? We asked some of the country's hottest small-cap traders to tell us

No one ever said investing in fast-growing companies wasn't risky. In fact, after the walloping they took last year, small-company growth stocks are decidedly not for the faint of heart. But despite last year's volatile market, many growth companies surpassed earnings expectations in 1994, and some investors still turned big profits.

We asked several experts to analyze the stocks represented in this year's Inc. 100, and each analyst took pains to make this point: investing in growth stocks requires tons of due diligence, lots of patience, and faith that over time growth companies often reap the highest rewards.

In that light, the experts shared with us their top investment picks -- and their rationales. Several stocks were chosen by more than one investor, and usually for similar reasons. In most cases we decided to present only one adviser's analysis as representative of the rest. Here are the highlights:

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Richard Driehaus
President and CEO

Driehaus Small Cap Growth Fund

Driehaus Capital Management

Chicago

Assets: Manages $532 million, with a focus on small-cap stocks

Performance: An annualized return of 27.88% over the last five years

Top Inc. 100 Picks: Alantec, Alliance Semiconductor, PeopleSoft, Roberts Pharmaceutical, Wonderware

We're really growth buyers. We believe that earnings growth is the primary motive of all businesses and is crucial in determining common-stock prices over the long term. Everything else being equal, we look for companies with accelerating sales and earnings and what we call positive-earnings surprises, instances in which a company reports numbers that are sharply better than what the Street anticipated.

Alantec (#19) manufactures intelligent switching hubs for Ethernet and local area networks. It reported a strong quarter, ahead of earnings expectations, and revenues are up 113% from a year ago. We generally buy stocks that are increasingly attracting institutional interest, and we try to buy them earlier than most other investors do. Here's a company that's way ahead of plan and caused the Street analysts to raise their estimates. We feel Alantec's revenues can grow at about a 100% rate over the next several years. The company's long-term promise is excellent, and the market dynamics are very healthy. Also, Alantec's customer count is growing rapidly, the size of its orders is expanding, the sales cycle is shrinking, and its profitability is improving. And the company has made substantial investments in its infrastructure.

The industry outlook is important. We want to know if the industry outlook is better than, the same as, or worse than it was in the previous quarter. Two areas where you're going to see some improvement are health care and technology. In technology we're seeing a strong demand for personal computers, and it appears that the personal-computer business has left the phase of being part of a cyclical business and is becoming more like a consumer-electronics business. So tremendous computer power is being placed in the hands of individuals, and that, of course, stimulates demand for semiconductors.

Alliance Semiconductor (#39), a leading supplier of high-performance memory products, is another company we like. We're looking for upward revisions in which analysts raise the estimates sharply on a stock. Based on Alliance Semiconductor's very strong December quarter [earnings per share were 50% better than expected], the Street analysts raised their estimates this year significantly. The company employs a world-class design team focused on the high-volume mainstream markets, which have higher barriers to entry. That is where the company's engineering talent can shine. It's a well-positioned company. And I think the market is fully aware of its immediate and longer-term strengths. It's one of our favorite stocks.

We also look at companies that are reporting strong, consistent, sustained earnings growth. Companies that are more stable in nature have an above-average sector growth rate. Here we're talking about companies that are growing at a 30%-to-40% rate, and we're looking to make sure that the sales and earnings they've reported are going to continue.

Roberts Pharmaceutical (#10) is a company whose investments are now starting to pay off. The compound average long-term growth rate estimated by the Street for this company is between 40% and 50%, and earnings estimates are up by more than 70% from 1994. We think those figures may be conservative. We think there is a lot less risk in buying stocks that are heading higher based on new, positive information than in buying a stock that's heading lower and praying that it will turn around. For about a year and a half Roberts Pharmaceutical was going through a saucer bottom, in which the stock dropped down, but now it's coming back up and hitting a new recovery high. This is a very good company. It acquires and develops high-potential, undervalued, late-stage-development pharmaceuticals, and it's been good at it.

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Christine Baxter
Manager

PBHG Emerging Growth Fund

Pilgrim Baxter & Associates

Wayne, Pa.

Assets: Manages $265 million, with a focus on small-cap and microcap stocks

Performance: An annualized return of 38% since the fund's inception, on June 15, 1993

Top Inc. 100 Picks: Alternative Resources, Hollywood Entertainment, Network Peripherals, Papa John's International, Wonderware

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