Small Stocks Think Big: Shares of Little Companies Have Been the Bear Market's Lone Bright Spot. but Good Deals Are Getting Hard to Find, and Big Funds May Not Be the Best Bet

Article excerpt

Byline: Linda Stern

In the market these days, small is beautiful. Managers of the fledgling Aegis Value Fund, which specializes in small stocks, can barely keep up with all the money investors are throwing at them. Aegis is popular for good reason: last year it returned 42.7 percent. But with some $70 million pouring in the door in just the last two months, manager Scott Barbee and his partners are working nights and weekends to find pint-size bargains. "The pressure is definitely on,'' he says.

While most investors have been crying over their loser tech stocks and slumping Standard & Poor's 500 Index funds, shares of small companies have been booming. Ever since the technology-led bull market flamed out early in 2000, little companies have been outperforming the big boys, returning 10 percent while that S&P 500 lost 26 percent and the Nasdaq fell 61.4 percent.

Shares of small companies--those with stock valued at less than $1 billion--outperform over the long haul, but they can be riskier, too. Little firms are more agile than big ones and have more room to grow. When interest rates are as low as they are now, small firms have easy access to cash. And because they're less dependent on foreign business than the titans, they don't suffer when the dollar strengthens or overseas economies falter. Since 1926, small-company stocks have outperformed large-company stocks by 2 percentage points a year, according to Ibbotson Associates, a Chicago investment-research firm. Recent returns have been even stronger, and analysts like Standard & Poor's Sam Stovall say there's still room for more rally.

Small stocks especially shine coming out of recessions; in the first year of the last four recoveries, they've averaged 29 percent returns, according to T. Rowe Price data. "We still have a ways to go," says Preston Athey, manager of the T. Rowe Price Small Cap Value Fund. "These cycles typically last three to seven years."

Opportunists who jump in now aren't exactly getting to the party early. Since early 2000, investors have shoveled an incredible $51 billion into small cap funds, reports AMG Data Services. That's an amount far out of proportion to what's gone into other stock funds, and represents 25 percent of the funds' current total. "They're beginning to chase performance," says Athey, who worries that the amount of cash coming in will push managers to overpay for stocks they're forced to add.

That creates problems for fund managers like Barbee, who says he is determined to hunt for bargains, even if he has to hold on to cash for a long time. The pressure of prospecting for enough good little companies has caused seven small cap value funds to close to new investors in the last year; at least five others closed the year before. …