Finding the Sweet Spot

A study of the 7,350 stocks available for purchase on the three major Wall Street exchanges this year suggests that an investor would have to be a chained to an index fund or camped under an unlucky star not to have a portfolio that's in the black for 2002.

Professional or private fund managers who have lost ground might take refuge in the dreary fact that the S&P 500 and Nasdaq Composite are down 2% and 9%, respectively, so far this year. But their execrable performance should provide no excuse, for a portfolio of 10 stocks chosen at random at the start of the year would likely be well ahead.

Here are the facts:

Advancing stocks have outpaced declining stocks by a ratio of 1.6 to 1 so far this year, according to analysis that I performed on price changes from Jan. 2 to April 19. And the further you get away from the large-company stocks that dominate the two big indices, the better the win-loss ratio of stocks becomes.

Among the 27 stocks that boast market capitalizations greater than $100 billion, the win-loss ratio favors the losers by a 15-12 margin.

So big, so bad.

But as soon as you step back from the mega-cap stocks -- benighted names such as AOL Time Warner AOL, Nokia NOK, Bristol-Myers Squibb BMY and General Electric GE -- the dark skies part and winners emerge.

Among the 73 stocks with market capitalizations greater than $50 billion, winners beat losers 40 to 33.

Among the 152 stocks with market caps over $25 billion, winners beat losers 92 to 60.

Among the 354 stocks with market caps over $10 billion, winners beat losers 233 to 121.

Among the 612 stocks with market caps over $5 billion, winners beat losers by a margin of more than 2 to 1 -- 422 to 190.

Among the 1,651 stocks with market caps over $1 billion, winners beat losers by a margin of almost 2.5 to 1 -- 1176 to 474.

To investigate further where outperformance is coming from -- and where it might arise next -- let's pay a visit to Dr. Markman's laboratory.

2002 Win-Loss Ratio of Stocks by Market Capitalization
Market Cap	# of Stocks	Advancers %	Decliners %	Up/Down Ratio
$100B	27	12	15	0.80
50B	73	40	33	1.21
25B	152	92	60	1.53
10B	354	233	121	1.93
5B	612	422	190	2.22
1B	1,650	1,176	474	2.48
500M	2,371	1,666	705	2.36
250M	3,220	2,200	1,020	2.16
100M	4,336	2,862	1,474	1.94
All stocks	7,386	4,549	2,837	1.60
Note: Data from Jan 2, 2002, to April 19, 2002.

As you can see in the table, the win-loss ratio forms a bell-shaped distribution across market caps in 2002, with the peak occurring among stocks of $1 billion or greater. As market cap gets smaller or larger, the ratio shrinks.

Homing In on Winners

To more definitively identify the epicenter of success, I focused on stocks with market caps between $500 million and $5 billion, cut the deck in $500 million increments and calculated win-loss ratios again. I won't bore you with all the details, but I determined that the sweet spot so far this year is among stocks with current market caps between $750 million and $1 billion. Their win-loss ratio is an overwhelming 2.72 to 1, with 212 stocks in the plus column for the year and only 78 stocks posting losses.

Now, let's take one more step. You may recall that last week I reported on the wide disparity in performance between relatively cheap and relatively expensive small-caps (see A Smart Way to Play Small-Caps ). So, for my final cut of the data, I determined how growth stocks in the $750 million to $1 billion cohort have performed vs. their value counterparts.

The result: Among growth stocks, winners beat losers by a 2.13-to-1 ratio. But among value stocks, winners beat losers by a whopping 4.25-to-1 ratio, 85 to 20, as shown in the table below. (Values in columns 2 and 3 do not add up to column 1 because some stocks are not labeled "growth" or "value.")

Sweet Spot for Value Small-Caps With a Market Cap of $750M-$1B
Total # of stocks	Advancers % YTD	Decliners % YTD	Up/Down Ratio
289	211	78	2.72
	85	40	2.13
	85	20	4.25

This trend could change at any time, but it's more clear than ever that the most fertile ground for finding stocks in favor with the market gods today lies among value stocks with market caps in the $750 million to $1 billion range.

Now, it's possible to leverage this analysis to find stocks that looked like our winners at the start of the year. Simply export the 85 winners to an Excel spreadsheet, and calculate their median market cap and year-to-date gain. The answers are $853.2 million and 27%.

To clone the winning stocks, I have found it useful in years past to deduct the average gain from the average market cap, as that yields the average market cap of the market's most successful cohort of stocks at the start of their excellent run. In this case, it is $622.28 million. Now search for stocks with market caps "near" $622.28 million that are labeled as value stocks. Then, just in case the trend reverses and growth comes back in favor, do the same with stocks labeled "growth."

Recession-Proof Picks

One of the top value names in this list is URSURS, a heavy-construction company. Its shares are up 82% in the past 14 months; they weathered the bear market quite nicely, as expected, because of their low valuation and the company's successful financial restructuring and its ability to carve out a profitable piece of the government's massive transportation infrastructure buildout.

In the growth list, I'm attracted to FTI Consulting FCN, whose market cap was right in the sweet spot at $621 million when I wrote this column on Friday, but swelled to $678 million by Tuesday afternoon. FTI was founded in 1982 to provide forensic engineering and scientific services to the insurance, legal and manufacturing industries. But after a few key acquisitions in the late 1990s, it began to focus on providing financial restructuring, litigation consulting and accident investigation services. With headquarters in Annapolis, Md., it has the capacity to deploy about 350 professionals in SWAT teams from 33 offices nationwide. Net income in the 12 months ending Dec. 31 was $16.5 million on $166 million in revenue.

FTI's principal revenue generator is its turnaround, forensic accounting and bankruptcy practice. It is typically hired by a syndication of money center banks that holds troubled loans from messed-up companies like Enron ENRNQ and Kmart KM. FTI consultants advise the creditor on the best strategy to recover as much as possible -- and it will go so far as to put together a new business plan. The company's litigation consulting business is a leader in the art of helping law firms stage major courtroom cases, such as the O.J. Simpson trial in the mid-1990s, the Microsoft antitrust trial in Washington or the disputed presidential election trial in Florida in 2000.

Theodore I. Pincus, executive vice president and chief financial officer, said the business grew 40% year over year in 2001, as financial consulting, in particular, was driven by the extreme levels of corporate debt and record number of large bankruptcies. He said the firm believes it can steadily grow 15% to 20% each year for many years to come, however, as it addresses a fragmented market worth tens of billions of dollars in annual billings and battles few public competitors. Its only real impediment is the number of professionals it can hire, and with the confusion surrounding the future of Big Five accounting firms' consulting practices, the firm is having no trouble recruiting top talent. Cash flow is positive and growing, and exceeds net income growth -- and the balance sheet is as clean as you would expect from a company that spends most of its time cleaning up other companies' financials.

If this seems like a recession-proof business, you're right. Its customers are not making discretionary expenditures. "If you are in trouble with your bank or you've been sued to the value of your whole company, or your plant in Omaha has burnt to the ground, you have no choice -- you have to hire consultants and spend the money," Pincus said.

Skeptics will want to know how FTI will perform when the economy recovers, or if there is ever a drought of disasters, but Pincus notes that "as long as there is going to be debt, there will be troubled debt. As long as there are human beings, there will be poor decisions and poor strategies." He points out that Enron did not fail because of the economy; neither did the movie theater chains that overbuilt and ended up in Chapter 11. "You might imagine that bankruptcies will decline because we are at an all-time high," he said, "but we think it's just the tip of the iceberg."

FTI will announce first-quarter results and update expectations on Thursday. But based on current guidance, it looks as if the shares' forward price-to-earnings ratio for 2002 is around 25, which is more than reasonable for a well-run business in a growing field that has high barriers to entry and is growing at 15% to 20% a year.

I will add it to the official SuperModels portfolio with an expectation that it will advance from its current perch around $31 to reach the $46 area by the middle of 2003.