In Search of Stars That May Drive the Next Rebound

Wanted: stocks that still have the Big Mo--as in momentum.

Plenty of stocks that were high-fliers in May and June crashed in July and have barely budged since. But some issues have already come roaring back, and thus are attracting fresh attention on Wall Street.

And for good reason: The shares with the strongest upside momentum in recent weeks may be indicating which sectors will lead any sustained market rebound--or advance without one.

Clearly, the blue-chip names in the Dow industrial average have Big Mo, which reflects a classic “flight to quality” by nervous investors.

But many money managers are more interested in the smaller stocks that have either rocketed from their July lows or never fell much from their spring highs. The fast return of buyers to those shares, or the lack of selling in them even as the market slumped, is a sign of the stocks’ inherent strength--i.e., their earnings potential must be particularly robust, some Wall Streeters argue.

“What you want to find in a new bull-market move are new names to lead,” says David Ryan, manager of the New USA Growth stock fund in West Los Angeles. But that’s exactly why he’s suspicious about the market’s rebound so far, he says: “We don’t see many of those [new names] emerging” yet in the universe of smaller stocks.

*

Even so, Ryan is impressed with the fast turnaround in shares like McAfee Associates, a software developer that markets anti-virus, access-control and other such software. From a July low of $46.25 McAfee has surged to $61.75, just under its peak of $64. Also recovering quickly was CDW Computer Centers, a fast-growing telemarketer of personal computers, Ryan says.

Contrast the strength in those names, he says, with the devastation still prevalent among most high-tech issues, including some of the hottest names of spring, such as memory device company Iomega, or Brooktrout Technology. Their inability to snap back tells you that “they are going to have to put in a lot of time” languishing at lower levels, because investors have stopped paying attention to them, Ryan says.

Tim Miller, manager of the Invesco Dynamics stock fund in Denver, thinks the smartest bets in technology today are the biggest, proven names, such as database software giant Oracle, which barely dipped during the July sell-off.

He also says that two industry groups are showing noteworthy resilience, possibly signaling that they could lead the market in any rally between now and year’s end.

One of those groups is energy, specifically medium-size oil and gas exploration and production companies such as Noble Affiliates and Nuevo Energy, Miller says. “These are companies whose base [business] is growing at double-digit rates and which have significant exploration upside that is not reflected in the prices of their stocks,” he says.

Many of those energy shares declined only modestly in July, indicating that their owners were largely unwilling to part with them. Another fund manager, Louis Navellier of the Navellier Funds in Incline Village, Nev., sees the same kind of strength in offshore drilling stocks such as Reading & Bates and Sonat Offshore Drilling.

Meanwhile, some specialty retail stocks--specifically those chains serving teen girls--have quickly rallied from their July lows, Invesco’s Miller notes. He thinks that that group, including such chains as Wet Seal, Gadzooks and Claire’s Stores, is on the verge of benefiting from a demographic bonanza: a jump in the number of American teenagers.

Teen girls “are an under-served retail market now,” Miller says, “because that [store sector] was hit by the greatest amount of consolidation in the retail industry over the last few years.”

What is drawing buyers back to all of these Big Mo stocks is that they appear to boast very healthy earnings growth potential in a market where that trait is in ever shorter supply. But neither are these stocks inexpensive: Most sell for price-to-earnings ratios of 30 to 50 based on estimated 1996 earnings. That’s a lot lower than the 100-plus P-Es on many of spring’s high-fliers, but it’s still not cheap. Then again, the momentum game isn’t about what’s cheap--it’s about riding market leaders for as long as they can stay in the lead.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Still-Hot Stocks These stocks either rebounded quickly from July’s sell-off or fell only modestly in that decline, or both. The 1996 P-E is the stock price-to-earnings ratio based on analysts’consensus earnings estimate for the current fiscal year. *--*

July Tues. ’96 Stock low close P-E CDW Computer $36.67 $59.75 43 Claire’s Stores 26.38 28.50 21 Gadzooks 22.25 30.50 39 McAfee Associates 46.25 61.75 50 Mentor 25.00 27.13 24 Microchip Technology 21.00 36.88 24 Noble Affiliates 38.88 40.25 29 Nuevo Energy 30.75 33.63 35 Oracle Systems 36.00 39.88 31 Wet Seal 20.88 27.75 35

*--*

Note: All stocks trade on Nasdaq except Claire’s, Nuevo and Noble (NYSE). Source: IBES Inc. (earnings estimates)