20 Stocks For $20 - mid-cap stocks

Kiplinger's Personal Finance Magazine, Sept, 1999 by Robert Frick

Those pricey shares of the America Onlines and Amazon.coms of the world can cause anxiety, dizziness and a maybe-not-so-irrational fear of falling. By the same token, small-company stocks may seem like bargains these days, but with their dawdling returns and high risk they don't offer much security, either. So consider the middle: stocks of companies with about $1 billion in market capitalization (share price times number of shares outstanding) to about $10 billion.

So-called mid-cap stocks have much to recommend them. Their annualized return has almost equaled that of the mighty Standard & Poor's 500-stock index--17% versus 18% over the past ten years. And the volatility of these stocks is exactly the same as that of the S&P 500. That relative safety, plus good returns, makes mid caps "a kind of broad market bet with training wheels," says James Haynie, co-manager of Liberty-Colonial Select Value fund.

As extra icing, while mid-cap stocks are normally valued at a slight premium to stocks in the S&P 500 (based on such measures as ratios of price to earnings and price to cash flow), today they trade at a historically huge discount. The average P/E of S&P 500 stocks is 20% higher than that of stocks in S&P's MidCap 400 index. Says Harry Burn, co-manager of Sound Shore fund, a top-performing mid-cap fund: "The values are quite attractive across a pretty wide spectrum of companies."

Given this cheap state of affairs, we went shopping for markedly good bargains among mid-cap stocks priced at about $20, give or take a few bucks. While any finance professor will tell you that price is irrelevant--and most CEOs will never admit it bugs them that their company's stock price is so low--fund managers agreed that some of the most depressed and ignored companies fall into this price range.

The 20 stocks that made the final cut are an eclectic group. They include both growing companies and battered companies on the mend. What all of them have in common is low share price, valuations begging to be noticed and, perhaps most important, earnings that are forecast to increase in the next year.

Supplying the fertilizer for growing firms (cash)

1 ALLIED CAPITAL CORP.

When small to medium-size businesses need a loan, they usually turn to banks or maybe to business-development companies, the largest of which in this country is Allied Capital (symbol ALLC, Nasdaq, recent price $23). But Allied Capital is much more than a lender. It sometimes takes an ownership position in the companies it finances, and it supplies money for so-called mezzanine financing, given after standard secured loans and before a company either goes public or is sold.

If that sounds risky, it's not--at least not the way Allied Capital does it. At about 1% a year, the company's write-off of bad investments is minuscule. "There are banks in this country that would die to have a write-off that good," says Preston Athey of T. Rowe Price Small-Cap Value fund. "It doesn't take unnecessary risks, and it knows what it's doing."

Allied Capital used to be five related finance companies that merged into a single company last year. As a result, it now has the ability to make larger loans to bigger and higher-quality companies more cheaply, says John Fox, an analyst for FAM Value fund. Becoming a larger company has also attracted more analyst coverage to the stock, and those analysts are bullish on the company. In fact, they split about 50-50 over whether the company is a "strong buy" or just a "moderate buy," according to Zacks Investment Research.

Based on its dividend yield alone, it is remarkable that Allied Capital's stock trades as cheaply as it does. The company's P/E ratio is a modest 14 for 1999 earnings, and at its current price it sports a 7% yield. Earnings for 2000 are expected to increase by 19% to $1.96 per share.

The real power for this utility comes from telecom

2 CITIZENS UTILITIES

Calculating the value of assets in a conglomerate can be tricky, but if you dig deep enough, sometimes you can find gold--even in a company made up of many mundane businesses. Consider Citizens Utilities (CZN, NYSE, $12), which provides electric, gas, telecommunications and water services in parts of 19 states. If you add up the value of its individual businesses, says Sound Shore fund's Burn, the company's value is about $15 a share.

The lion's share of the company's business (about 60% of its revenues) is telecom service, which Burn figures alone is worth about $11 a share. That segment grew 18% last year, but its profits were sapped by the company's 83% ownership stake in Electric Lightwave, which mainly provides data communications along a nationwide fiber-optic network. Though revenues at Electric Lightwave almost doubled within the past year, it lost $35 million on revenues of $38 million in the first quarter of 1999. Still, Citizens Utilities steadfastly supports the company, and Burn calls it a good investment as well.

Analysts predict earnings at Citizens will rise about 70%, from 19 cents this year to 32 cents in 2000, and that may spark a price rally.