Small caps are paying big returns, at least for now. (Up Front).

By and large, Wall Street's recent enthusiasm for small cap stocks has been good news for the San Fernando Valley's publicly traded companies.

On the back burner for most investors through the stock price run-up of the late 1990s, these lower profile companies are getting far more attention from the Street, a focus that is helping to increase their valuations.

A sample of 20 Valley businesses included in the Russell 2000 Small Cap Index advanced nearly 3 percent in the first quarter of 2002, just slightly behind the 4-percent increase in valuations for all the Russell index companies in the quarter.

Like the broader market, the gains were even more dramatic in consumer-related businesses, and far less impressive in the technology sectors, which saw steep drops in valuations, no matter what the company size.

"Small caps were a better bargain," said Brad Lawson, senior research analyst with Frank Russell Co., which compiles the Russell indexes of stock performance. "The other part is that when the economy comes Out of a recession, small caps do better than large caps."

Small caps, typically defined as stocks with market capitalizations no greater than $1 billion and no smaller than $250 million, were largely ignored through the bull market of the late 1990s, when stock prices soared for multinational, blue-chip companies and promising technology growth stocks. Small caps now seem cheap by comparison, and investors are buying them betting that their values will increase.

At the same time, many of these small cap issues tend to be simpler businesses without a great deal of diversity. They tend to rebound more quickly because improvements in sales go directly to the bottom line, whereas large cap companies with highly diversified, global operations may not see a turnaround until the economy makes a full recovery.

As a result, the first quarter of the year brought better returns to small caps than it did to large companies, with yields advancing 4 percent on the Russell index and 7 percent on the S&P 600 index of small cap companies. In contrast, the Russell 1000 Index, representing the country's largest businesses, grew by a mere 0.7 percent in the first quarter, the S&P 500 was flat and the Nasdaq Composite fell 6 percent. Only the Dow Jones Industrial Average matched the small cap performance with a 4-percent increase in the first quarter.

Included in the Russell 2000 Index, which has a greater number of Valley companies than does the S&P, were 11 local businesses that gained an average of $4.62 in share price, or about a 16-percent increase in value.

Among the best-performing Valley stocks in the first quarter of the year were Unova Inc., up $2.40 or 44.9 percent in the quarter; Pinnacle Entertainment Inc., with a 34.3-percent increase in its share price to $8.06; Ryland Group Inc., up 24.7 percent to $90.20 in the quarter; Digital Insight Corp., up 19.5 percent to $27.55; and K-Swiss Inc., with a 26.8-percent increase in its stock price to $41.98 in the period.

But the rising tide of valuations for small caps has not carried all companies along with it. Seven more Valley companies included in the Russell index saw their share prices slide an average of $3.02. Those stocks lost an average of 14 percent of their value since Jan. 1.

The share prices of the remaining two companies included in the Russell Index were virtually unchanged in the first quarter.

"It's definitely a function of the sector," said David Blitzer, chief investment strategist for Standard & Poor's.

Investors are distinguishing between small cap growth stocks, usually technology companies, and value stocks, and showing a decided preference for the value side of the equation.

"Growth stocks are more likely to be bought with expectations for high growth in the future as opposed to, 'Oh my gosh, I can't believe it's as cheap as it was,"' Blitzer said. "And when you get a market going through turmoil, value is what people go bottom fishing for."

Within the Russell 2000, so-called consumer discretionary businesses were up 9.2 percent. Technology was down 10.2 percent for the quarter.

Perhaps not surprisingly, technology stocks were among the Valley's worst performers as well. MRV Communications Inc. lost 38.4 percent of its value, with share prices plummeting to $2.82 per share; Ixia shares declined $3.77 or 30.7 percent; and Optical Communication Products Inc. lost $1.18 per share or 29.5 percent of its value in the first quarter of the year.

To some, such volatility in the small cap market means that the recent trend favoring those stocks is just that -- a trend unlikely to be sustained as market cycles shift.

"(Small caps) don't trade much, so any marginal, tiny interest in a company can result in a big price change," said Michael R. Murphy, managing director of US Bancorp Piper Jaffray. "I think what's happened over the last few months there has been what I would describe as a temporary blip in these small caps. As soon as things return to the more normal, long-term dynamics focused on large, liquid and what I would describe as usually favored types of names, these companies will continue to flounder."

A recent Piper Jaffray analysis of small cap performance found that these stocks do not outperform large cap stocks in the long term for several reasons, but perhaps most important among them is the fact that small caps do not trade in enough volume to interest analysts in covering them. Along with an increased concentration of funds in the hands of institutional investors, these dynamics make it more difficult for small caps to continue to increase their valuations.

Because fewer analysts cover these stocks, the opinion of a single pundit can push the share price dramatically up or down, as can one large trade by an investor close to the company.

"For some of these stocks, it could be because the brother-in-law of the founder decided to sell 10,000 shares," Murphy said. "It looks big on a percentage basis, and everyone scrambles to wonder why, and it's no big deal."

Others, however, say that there is a long history of small caps leading the market following recessions, and these companies are likely to continue to increase in value over the coming year.

"If someone is an aggressive investor, then you ought to put some money on small caps," said Blitzer. "This is a spot, when it's hot, it's incredibly hot. When it's cold, it's not going to cost you a whole lot."

Thinking Small

Valley's top performing small cap stocks

                                   Share Price        Percent
Company                      1/2/02    3/28/02 (*)  Change

Unova Inc.                    $5.49      $7.96       44.9%
Pinnacle Entertainment Inc.    6.00       8.06       34.3
K-Swiss Inc.                  33.09      41.98       26.8
Ryland Group Inc.             72.28      90.20       24.7
Digital Insight Corp.         23.05      27.55       19.5

(*)First and last days of trading in the first quarter of 2002

Source: Bigcharts.com