Defense-oriented stocks in the Washington area are under a cloud because of investor concerns about military budget cuts and uncertainty over government guidelines that could reduce company profits.
That, in essence, is the view of analyst May G. O'Leary of Baker, Watts & Co., a regional brokerage house based in Baltimore. O'Leary is a specialist in defense and high-tech stocks.
"For the past six to 12 months, the investment environment surrounding defense-related stocks has been negative, primarily because of perceptions regarding lower military budgets and reduced profit guidelines," O'Leary said.
Late last year, she noted, the Defense Department issued guidelines intended to control profits on defense contracts. The guidelines, O'Leary said, affect each company in a different way, and are now being revised.
"The ultimate outcome of the guidelines and the effects on different companies may not be known for several months or possibly longer, which creates continuing uncertainty, thereby resulting in added pressure on the stocks over the near term," she said.
Revenues and margins already have been squeezed at many defense contractors and current programs are being stretched out, O'Leary said. Even so, she added, "We feel there are pockets of opportunity that center around the smaller, niche defense contractors."
At least two areas of the defense budget, operations and maintenance and research and development, will grow rapidly, O'Leary said. And that will benefit several Washington firms, including BDM International of McLean, ERC International of Fairfax and QuesTech of McLean. All three are worth more than their market prices, O'Leary said.
"When the turnaround comes and the psychology of the defense marketplace becomes more positive, we expect these stocks to be major performers," O'Leary said.
O'Leary's views were contained in her new Defense & Technology Quarterly, which establishes a new index for area high-tech stocks.
It is called the Defense and Technology Index and will track 20 small and medium-size companies, some of which are heavily dependent on government contracts. Others have significant commercial business.
The new Defense Tech index shows the 20-stock average rising rapidly along with the market in January, February and March and then sliding sharply in April, May and June.
Overall, from Jan. 1 to July 2, the Defense Tech index rose 22.8 percent while the Dow industrials were up 28.5 percent. The Standard & Poor's 500 was up 26.2 percent and the Nasdaq composite up 22.1 percent.
Thus, the blue chips kept going while smaller stocks fell backwards.
The 20 companies in the index are: American Management Systems, Atlantic Research Corp., BDM International, Biotech Research Laboratories, Computer Entry Systems, DynCorp (formerly Dynalectron), ERC International, Fairchild Industries and Flow General, Iverson Technology, Life Technologies, QuesTech, Radiation Systems, Software AG Systems, Star Technologies, Survivial Technology, UNC Inc., VM Software, Verdix Corp. and VSE Corp.
Until last week, VM Software of Reston, which went public in May 1985, had never been forced to announce that its profits had dropped. Almost since the company was founded by Robert Cook six years ago, sales and profits have gone straight up.
On Friday, the company stumbled. VM Software's second-quarter report showed profits dropped to 2 cents a share from 15 cents a year earlier. "The second quarter was a struggle for us," Cook said.
The impact in the market was severe. The stock, which closed Thursday at $21, opened late on Friday and finally began trading at $18.50. The stock closed at $15.88 on very heavy volume, down $5.13 on the day.
Actually, VM Software stock has been sliding since the end of March. It opened the year at $20.25, shot up to $45 for a gain of 122 percent, and then dropped to $22.75 on July 2, reducing the gain to 12.3 percent. The sell-off Friday took the stock below its price at the start of the year.
Why did it happen? Kevin McNerney, vice president for finance, said the forthcoming introduction of IBM's 9370 computer was turning out to be a mixed blessing. It will be very good for VM Software's business but temporarily it was causing additional expense and creating uncertainty among potential customers about how to spend their computer dollars.
Iverson Technology shares took a $3.25 bounce Friday when the company announced a $135 million contract with the FBI for 8,000 of its high-security Tempest work stations. Iverson stock, which opened Friday at $12.50, closed at $15.75. Eliot H. Benson, research director at Ferris & Co., said he thought the shares were still attractive, despite the runup in price.
Incidentally, Iverson recently postponed a proposed $11.5 million offering of convertible debentures and a new class B common stock that would have created two classes of stock with unequal voting rights. The company said that an expression of concern by the SEC over unequal voting rights caused them to postpone the offerings. The SEC is still wrestling with the one-share, one-vote issue.
When last we looked at Ameribanc Investors Group of Annandale, Peter S. Zwart, a European investment adviser, was angry with management because they had missed a chance to sell Ameribanc Savings Bank to NCNB Corp. of North Carolina. Ameribanc President Bill Savage said it would have been a bad deal but Zwart, a former Ameribanc chairman, promised to bring in other possible buyers.
What Zwart would not say, at the time, was whether he would buy more shares in an effort to gain control of the company. Zwart represents a group of European investors in a voting trust who hold 1.7 million shares, or 28 percent, of Ameribanc stock.
A few days ago, Zwart filed a new report with the SEC. It listed seven groups holding an additional 803,000 shares who are not in the voting trust but have a relationship with Zwart's investment group. What that might mean in a battle for control is not clear.
Trading in Ameribanc stock has been heavy in the last few weeks and by one informed estimate, Zwart has added 400,000 shares to the block he controls. If so, that would give him perhaps 35 percent of the shares. The stock closed Friday at $12, after rising from $10.25 on June 19, a gain of 17 percent.
Zwart also filed a copy of his agreement with voting trust members that gives him the option to seek a buyer or to buy or sell additional shares. Investors would pay expenses plus a maximum of 2.5 percent of the value of their shares. On a sale, they would pay a maximum of 5 percent. Under the agreement, Zwart could not sell the stock for less than $12 a share.
What happens next? Ameribanc watchers think Zwart may be positioning himself to force a sale of Ameribanc but more may be known after the next directors meeting Aug. 6.
If you had any doubt about the way the big, blue-chip stocks have dominated the market in the last two years, you will find ample evidence by comparing the performance of the 30 area stocks that make up the Johnston, Lemon & Co. index with the performance of the broader market averages.
From 1982 through 1985, the J&L index ran far ahead of the Standard & Poor's 500. But it barely kept up in 1986 and so far this year, it is running behind.
Some of the early years saw truly dramatic performances by the 30 local stocks. For instance, in 1982, the J&L index was up 59.5 percent while the S&P rose only 14.8 percent. In 1985, J&L rose 42.1 percent while the S&P was up 26.3 percent