For nearly three years now, Michael L. Mead, the director of research at the brokerage firm of Scott & Stringfellow in Richmond, has been charting the ups and downs of 10 Washington area high-tech companies.
Mead calls his chart "the beltway technology index." From watching the stocks in the index and from writing frequent reports on the performance of the companies, Mead and his associate, May Graves O'Leary, have developed a keen sense of what is happening in the high-tech world around the beltway.
The key fact about the index, says Mead, is its volatility. Most of the companies it lists depend heavily on government contracts, which leads to a feast-or-famine climate. Contracts are won, contracts are lost, there are acquisitions, write-offs and other major events, says Mead, that tend to increase the volatility of high-tech company earnings and stock prices.
"The stock action reflects the business," Mead says.
For the investor, Mead notes, this volatility offers an opportunity for market timing. This is the technique of timing one's stock purchases and sales to take advantage of the rise and fall in the fortunes of individual companies.
"If you're good in market timing," says Mead, "these stocks can be rewarding. They outperform the S&P Standard & Poor's 500 in strong markets, and they underperform in weak markets."
Technology stocks, as a group, have been getting clobbered recently, and that fact is mirrored in the current beltway index reading of 126.3. The index, which started at 100 on July 31, 1982, just before the August 1982 bull market, went as high as 246.8 on June 16, 1983, and dropped as low as 118.87 on July 20, 1984.
With the stock market running close to its all-time high, investors looking for out-of-favor groups may want to do some prospecting among the beltway technology companies, Mead says. But he cautions investors to be selective. "Each company," he says, "has its individual story, and sometimes there are dramatic events that affect them."
The 10 companies that comprise the beltway technology index are Atlantic Research, BDM International, C3 Inc., Dynalectron, Flow General, Hazelton Laboratories, MCI Telecommunications, Penril Corp., Radiation Systems and Syscon.
Mead and O'Leary also monitor seven other companies: Essex Corp., ERC International, Genex Corp., Planning Research, Software AG Systems, Systematics General and Verdix Corp. But the index has been limited to 10 companies for the sake of simplicity.
The high-tech companies included in the index are a diverse group, cutting across the fields of chemistry, electronics, computers, technical services and communications. When he started the index, Mead said, he purposely sought a way to look at a range of the Beltway companies as a group.
Looked at individually, some beltway technology firms are riding high, others are struggling. In their May 30 report, Mead and O'Leary have lowered their 1985 earnings estimates for six of the 10 companies in the index and for 11 of the 17 companies they follow.
The 11 companies given lower earnings estimates are Dynalectron, Essex Corp., ERC International, Flow General, Genex (which was hard hit last week when it lost a contract that was its major source of revenue), Hazelton Laboratories, Penril, Planning Research, Radiation Systems, Syscon and Systematics General.
There are as many reasons for lower earnings estimates as there are companies, but O'Leary says she finds several common themes. The weakening economy is being reflected in the weakening of some high-tech businesses. Greater competition for government contracts and delays in those contract awards have affected several companies, notably Radiation Systems.
For Radiation Systems, which manufactures high-tech antenna systems, O'Leary and Mead foresee improvement. They estimate that earnings for the fiscal year ending June 1985 will come in at 65 to 70 cents a share, instead of the $1.05 projected earlier. But they expect the company's earnings to recover next year. The key to recovery, they say, is the amount of contracts booked over the next three to four months, and the company tells them it expects new contracts soon.
Of the 11 companies on the lowered-earnings list, seven are selling close to the low point of their 1984-1985 price ranges. They are Essex Corp., $4, (range $6-$4); ERC International, $5.13, ($10-$4); Flow General, $4.25, ($10-$3); Genex, $2.63, ($17-$3); Hazelton Laboratories, $12.25, ($14-$9); Penril, $11, ($15-$10); and Radiation Systems, $9.75, ($19-$9).
Of these companies, O'Leary thinks Radiation Systems has the best chance for a comeback. Mead thinks ERC and Hazelton are worth watching for upward movement in the next 12 to 18 months. ERC is still wrestling with the startup costs of its InterCAD subsidiary, and Hazelton is undergoing changes. Hazelton recently bought back 14 percent of its stock from Ralston Purina for $6.3 million and agreed to sell an equipment operation, Hazelton Systems Inc., for about $10 million.
Three companies on the lowered-earnings list are selling at relatively higher prices. Dynalectron, at $14.75 ($15-$10), has been troubled by cost overruns and the loss of government contracts, but also has picked up some new contracts. Planning Research, at $13 ($18-$9), continued to have problems with its engineering group but appears likely to benefit from its acquisition of Kentron.
Syscon, a firm that develops government computer software products, is in the most hopeful position for rapid recovery, O'Leary believes. She has put the stock, selling at $16 ($19-$12), on her recommended list. O'Leary said she is encouraged by Syscon's recent $28.5 million Navy contract. Although she dropped Syscon's earnings estimate for the May 1985 quarter by 2 to 3 cents a share, she foresees a pickup in revenue.
The two most consistent growth companies in the index are Atlantic Research, which has a five-year growth rate of 55 percent, and BDM International, with a 41 percent growth rate. Both are selling at top prices. Atlantic Research, at $35.25 ($40-$22), is recommended by Mead and O'Leary for purchase under $35. BDM, at $21.63, ($22-$10), which just split 2 for 1, is recommended for the long term. Atlantic Research will split 3 for 2 this week.
Beleaguered MCI Telecommunications, at $7.88 ($16-$6), was hit by a smaller-than-expected award in the AT&T trial -- $113 million versus estimates of $1 billion to $2 billion. Despite that, Mead and O'Leary believe business conditions for MCI will be favorable enough down the line to bring the stock to the $14 to $15 area.
There are buying opportunities, Mead said, for the investor who takes the time to study these companies carefully.
International Bank, which lost $8.8 million last year, has deferred dividends of its Class A and common stock for the second quarter. The company also deferred its first-quarter dividend. It had been paying 6.25 cents quarterly. . . . Halifax Engineering of Alexandria says it will exceed its $27 million revenue target for the fiscal year ending in March 1985 but still will report a $650,000 loss. . . . Investors S&L of Richmond is offering 1.1 million shares of 95 cent convertible preferred stock at $10 each. Shares are convertible at $7.50 per share of common stock. . . . Correction: In last week's column on Hechinger Co., the 5-for-4 stock split listed for June 1984 should have read June 1985.