Small-Caps Lure Buyers as Stocks Tumble This Month (Update1)

By Lynn Thomasson and Alexis Xydias

Nov. 26 (Bloomberg) -- The cheapest small-cap stocks in four years are luring equity investors battered by the biggest monthly losses since 2002.

Money managers from Raiffeisen Capital Management in Vienna to Highmark Capital Management in San Francisco are snapping up shares of companies with market values below $2.5 billion. The lowest prices compared with earnings in Europe and cash flow in the U.S. have made bargains out of Trinity Mirror Plc, the London publisher of the Daily Mirror, Arques Industries AG, a Starnberg, Germany-based investment company, and Labor Ready Inc., a Tacoma, Washington-based supplier of temporary workers.

Investors are seeking refuge after seven of the 23 national markets in the MSCI World Index tumbled at least 10 percent in November and the benchmark lost 6.9 percent through last week, the biggest monthly decline since the bull market began in October 2002. U.S. small-caps trade at the widest discount to stocks in the Standard & Poor's 500 Index in four years.

``We are finding more and more small-caps that are well managed and very cheap,'' said Herbert Perus, head of equities at Raiffeisen, which oversees $62 billion. ``You have to take the pain and have cool nerves in the current market and buy whatever is out of favor.''

Perus bought Trinity Mirror shares, expecting a rebound from this year's 27 percent decline. The company traded at 1.4 times book value, or assets minus liabilities, this month, the lowest since December 2003. He also owns Arques, which gained 46 percent in 2007 and announced last week that third-quarter profits almost tripled.

Russell 2000

Companies with lower market values lagged behind larger shares since the collapse of subprime mortgages contaminated capital markets in July. Through last week, the MSCI World Small Cap Index had lost 0.9 percent in 2007, heading for its first decline in five years, compared with a 5.6 percent gain for the MSCI World Index.

The MSCI World climbed 0.8 percent as of 10:30 a.m. today in London after gains in U.S. retail sales showed consumer demand remains resilient in the world's largest economy. The MSCI Asia Pacific Index rose 2.7 percent and Europe's Dow Jones Stoxx 600 Index added 0.9 percent.

The Dow Jones Stoxx Small Index, a benchmark for the smallest European stocks, increased 1.6 percent today.

The Russell 2000 Index, a gauge for U.S. small-cap stocks, is set to underperform the S&P 500 for the first time since 1998, as the worst housing slump in 16 years weighs on the nation's economy.

Rising in Recession

The Federal Reserve cut its 2008 growth forecast last week and expects the economy to expand 1.8 percent to 2.5 percent. The median estimate in a Bloomberg survey of economists from Nov. 1 to Nov. 8 predicted 2.1 percent growth this year, and 2.4 percent in 2008.

Smaller was better during three of the last four recessions as defined by the National Bureau of Economic Research. When the economy was shrinking from January to July of 1980, the Russell 2000 rose 5.5 percent compared with the S&P 500's 6.6 percent gain.

From July 1981 to November 1982, the small-cap index advanced 9.4 percent, while the S&P 500 gained 5.8 percent. The Russell 2000 returned 5.9 percent from July 1990 through March 1991 as the benchmark for larger stocks rose 5.4 percent. During the last recession, from March through November 2001, smaller companies added 2.3 percent while the S&P 500 fell 1.8 percent.

Equities extended their month-long declines last week, with the MSCI World falling 0.9 percent and the small-cap measure losing 2.7 percent. The S&P 500 dropped 1.2 percent and the Russell 2000, 1.9 percent.

`Big is Beautiful'

It's too early for small companies to rebound, said Patrik Scheuber of Swisscanto Asset Management in Zurich. He favors Merck & Co., expecting the Whitehouse Station, New Jersey-based drugmaker to weather the slowdown.

Merck, with a market value of $125.5 billion, raised its 2007 profit forecast last month on growing sales of a cancer vaccine. The third-biggest U.S. pharmaceutical company's shares rose 32 percent this year and trade at 18.4 times estimated earnings.

``Big is beautiful,'' said Scheuber. ``Especially now. Small-caps are more likely than large-caps to have negative revisions.'' Swisscanto Group oversees the equivalent of $57 billion.

U.S. Exports

Smaller U.S. companies are taking advantage of faster communications and fewer trade barriers to grab a bigger share of U.S. exports, according to a Commerce Department study this month. American businesses without international subsidiaries accounted for 46 percent of sales abroad in 2005, up from 38 percent in 1999, the report showed.

Richard Jandrain, who helps oversee $190 million at Fort Washington Investment Advisors Inc., says overseas demand for mobile phones with extra features will boost Greensboro, North Carolina-based RF Micro Devices Inc. The maker of chips and radio systems for mobile phones has a market value of $1.1 billion and got 93 percent of its revenue from outside the U.S. in the year ended in March, according to data compiled by Bloomberg.

RF Micro fell 17 percent this year because of higher-than- expected costs to produce its newest microprocessor. The company trades at 6.9 times annual cash flow, the lowest since at least 1998, weekly data compiled by Bloomberg show.

`Beat up'

``The stock has just gotten beat up,'' Jandrain said in an interview from Columbus, Ohio. ``It's attractive on valuation and has strong fundamentals.''

RF Micro and the other Russell companies trade at an average 10.3 times cash flow, Bloomberg data show, compared with 10.9 times for S&P 500 companies, the biggest discount since 2003. Europe's Stoxx Small Index traded at 14.3 times earnings last week, the cheapest in at least four years, the data show.

Lower prices are luring Highmark's David Goerz to Labor Ready, which has a market value of $676.4 million after tumbling 16 percent this year on waning demand for construction workers. The stock trades at 10.5 times earnings, the cheapest since Bloomberg started tracking the weekly data in 1994.

``Investors are too concerned about what's happening with the subprime shakeout,'' said Goerz, who oversees $22 billion as Highmark's chief investment officer. ``We're not going to have a recession here. It's an interesting time to start thinking about small-caps.''

French Waste

The declines sparked by the subprime collapse led to indiscriminate selling, said Jerome Forneris at Banque Martin Maurel in Marseille, France. He's been buying shares of Derichebourg, a Paris-based waste processor and provider of corporate and airport services, and homebuilder Les Nouveaux Constructeurs SA.

Paris-based Les Nouveaux Constructeurs is the cheapest stock relative to estimated earnings in the 27-member Bloomberg European French IPO Index. The measure tracks French companies during the first year they are publicly traded.

``What do these businesses have to do with the U.S. housing crisis?'' said Forneris, who helps oversee $8.1 billion. ``Waste collection in France won't be affected by U.S. subprime. The best time to buy is during a sell-off, when people lose sense of prices. One must buy now.''