Outlook '88 : Area Stocks / Institutional Investors See Potential in Off-Beaten-Path County

Times Staff Writer

Institutional investors cast long shadows on Wall Street, but they have traditionally steered clear of smaller public companies, such as those common in Orange County.

But their presence in the county increased significantly in 1987, and market analysts predicted that institutions will exert even more influence on local corporations in 1988 and future years.

An even bigger influence will be the direction of the overall market, but analysts are divided in their forecasts. Several are mildly optimistic to downright bullish, while others foresee further declines in the aftermath of October's unprecedented market crash.

In any case, the expected increase in institutional ownership is likely to be a mixed blessing for county companies, analysts said.

The presence of these market heavyweights signals that many local companies have moved out of the shadows and into the spotlight of the investment world, which could result in increased demand--and higher prices--for county stocks.

On the other hand, the frequent buying and selling of stock by institutions--and their emphasis on short-term returns--could have a destabilizing effect on companies accustomed to more loyal, long-term shareholders.

But for better or for worse, market observers believe Wall Street's big boys are here to stay, and their increasing involvement is just one more factor to be reckoned with in an increasingly volatile market.

"Institutions' role in the market can't be underestimated. And it's only growing," said Jeff Kilpatrick, president of Newport Securities, a stock brokerage firm in Costa Mesa.

Institutional investors include pension funds, banks, insurance companies, labor unions, profit-sharing plans and college endowments.

Although institutional investors own less than 50% of the shares listed on the New York Stock Exchange, they account for as much as 75% of daily trading volume in Big Board stocks.

When institutions begin buying a company's stock, the large number of shares purchased can quickly pump up its price and lead to a chain-reaction of buying by other institutions.

Traditionally, institutions have placed most of their equity investments in the stocks of America's largest corporations. They have tended to shun "secondary" stocks issued by smaller companies.

The reason, analysts said, is that investing in secondary issues requires expanded and time-consuming investment research. In addition, it is difficult for an institution to buy or sell large positions in secondary stocks without causing sharp price swings.

County stocks have tended to be even more overlooked than other secondary issues, because of the location of the companies.

"Geographically, Orange County is remote. It's off the beaten path," said James Reynolds, director of research at Cruttenden & Co., an investment banking firm in Newport Beach.

Investing in small companies is made more difficult because the companies have fewer shares available for purchase.

Further, larger, blue-chip companies have tended to have more established and stable track records, and their more steady market performance provides institutional investors with an additional measure of comfort.

Smaller companies, in contrast, have tended to be relatively young and unproven; their more erratic performance often means dramatic market swings.

But as large-capitalization stocks reached record price levels in early 1987, institutions began looking for values elsewhere. And when the blue chips tumbled in October and remained volatile the rest of the year, institutions realized that their traditional investment choices were not as stable as they had assumed.

"Their blue chips had been going straight up (in value) for three years, and they didn't want to be bothered by other stocks," Kilpatrick said. "That's not true anymore."

Another factor behind the increase in institutional investment in the county is that the nature of business here has been changing for several years.

"The companies here are growing. They're not going to stay secondary companies any longer," said Brian Callahan, an account executive at the Anaheim office of Prudential-Bache Securities.

"Orange County has been slower to develop, but it is now where Santa Clara County was a few years ago," said Reynolds, who joined Cruttenden last summer after working at the brokerage firm of Crowell, Weedon & Co. in Los Angeles. "There were lots of good companies there five to 10 years ago, and now there are lots of good companies here."

Reynolds' move is an example of the changing nature of the county's investment community. Before he became research chief at Cruttenden, the firm had no formal research department and was content to publish only an occasional report about county businesses.

Reynolds said he plans to publish regular research reports on local companies and send them to investment bankers and brokers in New York and Boston, where most institutional investment decisions are made.

Most stock market analysts are in the East, although there is a sizable contingent in San Francisco. "Even in Los Angeles, you have a tough time getting attention," Reynolds said.

"There are a tremendous number of potentially undervalued companies here that just don't get the attention they deserve," said Scott Hutchinson, executive vice president of Cruttenden. "We're trying to develop financial support for these companies for when they go public."

Institutional involvement obviously does not ensure that stocks will perform well. In fact, many market watchers blame institutions at least in part for the volatility of 1987's stock market.

"They make their investment slowly, but they get out very fast," Callahan said. "It makes the market very turbulent."

In 1987, the market was turbulent indeed. While the Dow Jones industrial average posted a slight gain of 2.3%, ending the year at 1938.83, the blue-chip index gyrated within a range of more than 1,000 points.

On Oct. 19, a day that has become known as Black Monday, the Dow plunged an unprecedented 508 points in a near-meltdown of the nation's stock exchanges.

Although the Dow retraced its losses by the year's end, indexes for transportation and utility stocks were down for the year. And many secondary stocks, which had not risen as high as the blue chips during the five-year bull market that began in 1982, also lost ground for the year.

Of 127 county stocks tracked by The Times, 28 gained in value, 12 were unchanged and 87 lost value in 1987.

Most of the county's top market performers were profitable, and most of the laggards reported losses for the year, but their stock price changes were caused by varied factors.

Bridgford Foods, an Anaheim maker of frozen bread dough and other convenience food products, was the year's biggest gainer, closing up 214.9% at $18.50 per share, contrasted with $5.875 at the end of 1986.

During 1987, but the company reported consistent earnings gains and introduced several new products.

"We had a good year, but we've had lots of good years. I don't know why the stock has gone up so much," Chairman William Bridgford said.

Investors snapped up shares in Computer Automation, the second-biggest gainer, partly in response to reports of a potentially lucrative patent cross-licensing agreement between the small Irvine company and giant IBM.

The stock finished the year at $8.875 per share, up 153.6% from 1986's close of $3.50. The stock had traded as high as $17 per share before the Oct. 19 market crash.

American Business Phones was the county's third-biggest winner, gaining 108.9% in value to close at $8.875, up from $4.25 a year earlier. In December, the Irvine marketer of telephone systems agreed to be acquired by TIE/Communications in a cash and a stock deal valued at nearly $16 million.

Stock in Irvine-based Armor All gained 79% in 1987, closing at $19.25 per share, up from $10.75 a year earlier.

The car-protectant manufacturer, which went public in 1986, successfully entered the car cleaner market in 1987; it announced plans to introduce a line of car wax and wash products.

VLI, an Irvine-based contraceptive maker, ended a yearlong effort to be acquired by a stronger company when American Home Products offered $6.25 per share for all of VLI's stock. VLI was the year's fifth-biggest gainer, closing at $6.25 per share, up 78.6% from $3.50 a year earlier.

Cushman Electronics was the county's biggest market loser of 1987, plunging 95% to close at 12.5 cents per share, contrasted with $2.50 at the end of 1986. The Newport Beach company, which markets telephone communications systems, reported a fiscal 1987 loss of $2 million and closed a major production plant during the year.

With some investors still smarting from from the bruises they received in 1987 and others eager to snap up potentially undervalued issues, stock market performance for 1988 is as tough as ever to predict.

Kilpatrick said he expects renewed investment in the stock market during 1988, "but investors have to be cautious about what they're buying."

With expectations of a stronger market in the first quarter of 1988, Kilpatrick predicted an increase in acquisitions and a better market for new issues. "There are a whole slew of private companies waiting to go public," he said.

Later this month, Kilpatrick plans to start the Orange County Growth Fund, a mutual fund that will invest at least 65% of its money in the shares of county-based companies.

"It'll probably be harder to raise funds for it now. But in the past 10 years, I couldn't have found a better time to get such good prices," Kilpatrick said.

The combined market price of the stock of many small companies is less than the amount of cash the companies have in the bank, said Jim McCamant, who follows several county stocks and is editor of the Berkeley-based Medical Technology Stock Letter.

"These companies have made progress in their business, but it's gone unnoticed."

Russell Diehl, president of Diehl & Co., a Newport Beach investment banking firm, said several county companies should do well in 1988. Overall, he said, the stock market should remain strong in the first part of the year but is likely to fall late in the spring.

"Look to April 20," Diehl said. "Mr. and Mrs. Six-Pack won't be concerned, but that's the six-month anniversary of when investors started investing after the October 19 crash."

Because stockholders who own stock for at least six months pay less taxes on any gains than those who sell sooner, Diehl said, institutional investors might begin selling shares in the latter part of April.

Dan Sullivan, editor of the Chartist, a stock market newsletter in Seal Beach, said the market might move up, but over the course of 1988, he expects the current bear market to continue.

"If it were behind us, it would be the shortest bear market on record. It's not going to be the shortest on record," Sullivan said. "The market was overvalued before, and it still is."

Callahan said the market might decline during 1988, but he is still recommending purchases of the stocks of several local companies, including Western Digital, MSI Data, Eldorado Bank, Pacific Scientific and Clothestime.

Callahan said he likes Western Digital because "it has as strong a management team as anywhere in California."

MSI Data, although not hard hit in the market crash, is a "strong company and is headed by a specialist in turning companies around," he said.

Eldorado Bank has done a good job of making quality acquisitions, he said, while Pacific Scientific has the potential to become a star player in the electronic instruments industry.

BEST AND WORST OF 1987 TOP TEN GAINERS

Company 1986 1987 % Close Close Change Bridgfd Foods $5.875 $18.50 +214.89 Computer Auto $3.50 $8.875 +153.57 Am Bus Phones $4.25 $8.875 +108.82 Armor All $10.75 $19.25 +79.07 VLI $3.50 $6.25 +78.57 MSI Data $11.125 $18.375 +65.17 Micro D $4.25 $7.125 +62.86 West Energy $.0625 $.09375 +50.00 Varco $2.625 $3.875 +47.62 Smith Inter $4.50 $6.50 +44.44

TOP TEN LOSERS

Company 1986 1987 % Close Close Change Cushman Elect $2.50 $.125 -95.00 Cardis Corp $7.875 $.625 -92.06 Care Ent (A) $3.50 $.50 -85.71 Fin Corp of Amer $7.50 $1.25 -83.33 TS Industries $17.00 $2.9375 -82.72 Viratek $63.00 $13.25 -78.97 ICN Biomed $14.875 $3.25 -78.15 SPI Pharmaceut $28.00 $6.50 -76.79 Biomerica $3.50 $.875 -75.00 Ceradyne $13.00 $3.625 -72.12

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