Wall Street Ignores L.A. Stars
If L.A.’s most profitable companies were a person, that person would be Rodney Dangerfield.
Despite making money year after year and giving their shareholders a solid, sometimes spectacular, return on equity, the majority of these businesses haven’t historically attracted a whole lot of respect from Wall Street. When viewed in the bright light cast by the technology companies that have been the darlings of investors for the past several years, many of L.A.’s public companies have seemed dull and unattractive.
But the technology sector is in turmoil, and once-favored Internet stocks are in the doghouse. Companies that make things and turn a profit doing so are getting more attention. So this should bode well for L.A.’s standard bearers, right?
Well, maybe.
“These are the kind of companies we’re buying now. It’s a wonderful opportunity,” said Peter Nolan, managing partner in leveraged buyout firm Leonard Green & Partners. “But I suspect it’s still going to be pretty rocky (for them).”
Yes, Internet companies that achieve escalating sales only by incurring escalating losses are out of favor. But the prevailing attitude that we are in the midst of a technological revolution remains. So although tech stocks may fluctuate up and down, that doesn’t necessarily bode well for non-tech stocks.
“It will take a while for the market to fall in love with the kinds of Old Economy stocks you’re talking about,” Nolan said.
Old Economy certainly describes the vast majority of L.A. County’s 50 most profitable companies of 1999, based on one-year return on equity, which is calculated by dividing net income by year-end shareholder equity. It is one way to measure how effectively a company is using its investors’ capital. In general, an annual ROE of greater than 30 percent is exceptional, in the 20s is above average and under 10 percent is sluggish.
Dearth of profits for techs
Only five non-aerospace technology companies are on the list, all of which have been buffeted of late after enjoying the market’s ride in 1999. The five are Gemstar International Group, THQ Inc., Xircom Inc., MSC Software Corp. and Creative Computer Applications.
Gemstar, L.A.’s third most profitable company with an ROE of 40.2 percent, saw its stock shoot up almost 400 percent last year, from around $14 to above $71. As of late last week it was trading at around $40. THQ, which posted an ROE of 30.2 percent, saw its stock rise 22 percent in 1999 from around $19 a share at the beginning of the year to above $23 at year end. Last week it was hovering around $15.
Most of L.A.’s high-ROE companies are in the manufacturing, real estate, retail/apparel or financial services sectors. While these industries employ hundreds of thousands of people and provide the backbone of the region’s diverse economy, they aren’t lighting many fires under investors.
That’s because most of these industries are mature, with steady but unspectacular growth rates. Investors until lately had been gravitating to the technology sector in part because many of the companies are relative newcomers and are growing at astounding rates.
Investors also have been tending to favor companies with large market values, of $10 billion or more. The most attractive, of course, are companies that are both growing fast and have large market caps. That simply doesn’t apply to most of L.A.’s public companies, regardless of how successful they are.
“Only six companies on (this year’s) list are over $1 billion in size, and the only real large-cap company is (biotech and pharmaceutical giant) Amgen Inc.,” said Bruce Mandel, president of Oakwood Capital Management in Century City. “Nobody cares for medium-growth companies that are small to medium-sized in capitalization. The name of the game is still high-growth large caps, even if they’re selling at high price-to-earnings ratios.”
Some hope for value stocks
Not everyone sees it that way. The recent tech turmoil has cooled, if not chilled, many smaller investors’ ardor for the sector. These investors are more likely to jump off the tech bandwagon, and perhaps take refuge in value-oriented stocks. Some of this is happening already, which could favor bottom-line-oriented companies.
“What happens with momentum investors is, they get scared and head for the hills,” said Andrew Kneeter, partner in Round Hill Asset Management, a boutique investment firm in Pasadena. “So you could see these kinds of companies, which are a little bit on the boring side, coming into focus.”
A few of these “boring” companies are already benefiting. Strong consumer-oriented stocks are attracting some interest with the economy humming along. Jeans manufacturer Guess Inc., No. 6 on this year’s list with an ROE of 31 percent, not only saw its stock jump 352 percent in 1999, but it is up more than 30 percent so far this year, to above $28 a share. The stock of contemporary shoe maker Skechers USA Inc., which had an ROE of 28 percent in 1999, has risen almost 200 percent since the beginning of the year, to above $10 a share. Guitar Center Inc. had an ROE of 24.1 percent, and is up about 40 percent this year to $14 a share. Discount retailer 99 Cents Only Stores posted an ROE of 16 percent. Its stock has risen around 40 percent this year, to nearly $40 a share.
But there are also profitable consumer-based companies that haven’t attracted investor attention. Sport shoe maker K-Swiss Inc. was No. 7 on the list with an ROE of 30.6 percent. Its stock has dropped by 16 percent so far this year, to about $14.50. Private-label clothes manufacturer Tarrant Apparel Group posted a 1999 ROE of 16.3 percent. Its stock has dropped 17 percent to below $8.50.
Inflation worries
Some of the factors contributing to the recent drop in the tech sector higher interest rates and fears of inflation could further hurt companies dependent on consumer confidence, such as retailers and apparel makers. If inflation does prove to be more of a factor in the economy, and interest rates continue to rise, it will directly affect pocketbooks.
“We’ve been in a major bull market expansion that has fueled consumer wealth,” said Terren Peizer, president of West Los Angeles financing and consulting firm Intellect Capital Group. But with many investors losing a great deal of their paper wealth in the recent tech shakeout, “I would assume that a major source of demand will suffer from the (negative) impact.”
Nor are profitable financial-services firms likely to see their stocks rise, because higher interest rates will cut into their profit margins. Banking companies like GBC Bancorp (ROE 22.5 percent), City National Corp. (ROE 18.9 percent), Imperial Bancorp (ROE 18.3 percent) and Cathay Bancorp (ROE 16.9 percent) are all small, regional players, although given the trend toward bank consolidation, they could see their stock prices rise if speculation arises that one of them is a takeover target.
So which of the profitable companies might pop up on the investor radar screen?
Oakwood’s Mandel, for one, believes that to garner attention, at least part of a company’s strategy must be online. By using the Internet effectively, the small to medium-sized companies that dominate L.A.’s landscape will acquire not only more customers, but capital.
“Some of these companies with cogent Internet strategies are ones people are going to be interested in,” he said.
But he also offers some solace to L.A.’s companies that are unlikely to get much more respect on Wall Street than they do now.
“The New Economy can’t do well without the Old Economy,” he said. “We really need for these companies to do well.”
