(FORTUNE Magazine) – After seven years as a market wallflower, small stocks are dancing again. Since October 11, the date of the stock market trough, small-fry shares have returned 44%, vs. 26% for Standard & Poor's 500-stock index. Owners of these stocks are jubilant, but they're also wondering how much longer the run can last. The word from the pros: Hold on, there's plenty more to come. ''This rally is very powerful,'' says Jack Laporte, portfolio manager of the $1 billion T. Rowe Price New Horizons Fund, the biggest of small-stock funds. ''It's more than just a flash in the pan.'' Laporte and others believe small stocks finally made their turn after a selling climax in the third quarter of last year. Last fall the P/E on Laporte's portfolio of fast-growing small companies was down to 96% of the P/E on the S&P 500. Only one other time, in 1977, was the relative P/E lower. After that nadir the fund went on to outperform the S& P 500 by nearly 300% over the next five years. Small stocks failed to keep up with their bigger brethren during the Eighties for many reasons. A declining dollar favored large exporting companies over smaller, domestically oriented businesses; the takeover craze centered on big companies that could be broken up; institutional investors shifted into stock-index funds that invest only in S&P 500 stocks; and foreign investors fell in love with big household-name American companies. But lately these trends have either reversed or slowed. The dollar, by most accounts, has bottomed; takeovers have ebbed; indexing is out; and foreigners aren't buying much these days. Chuck Royce, manager of the high-performing Pennsylvania Mutual Fund, believes this new environment could set the stage for a major shift in which small stocks outrun the big boys for years. In anticipation of another big rally for small stocks, Royce is picking up shares that have yet to move. He likes a few consumer stocks that were trounced by the recession, including Strawbridge & Clothier, Dress Barn, and Morrison, a food service company. These all sell for two-thirds of what they fetched before the recession. While earnings were down in 1990, they are all expected to rebound this year. One top-performing small stock fund, up almost 60% since the October trough, is Boston's $94 million MFS Lifetime Emerging Growth Trust, run by John Ballen. Among his favorite stocks is Office Depot (no relation to Home Depot), an office supply retailer. ''After the completion of a pending acquisition, Office Depot will have more than twice the number of stores of its nearest competitor in a growing business,'' he says. He also recommends baseball card company Fleer. It underwent an LBO in 1989 and reemerged as a public enterprise last year. It has already paid off virtually all of its long-term debt and is now enjoying vigorous growth. Stephen Lieber of the $680 million Evergreen Fund in Purchase, New York, is betting on First Team Sports. The company sells skates that roll on a blade of wheels (see picture). First Team's skate sales are more than doubling each quarter, and return on shareholders' equity is above 50%. Lieber also likes Airgas, which distributes industrial, medical, and specialty gases. Earnings were temporarily depressed by the sale of a subsidiary in 1989, but Lieber expects profits to rebound this year. Chris Najork, managing director of NFJ Investment Group in Dallas, is honing in on Cubic Corp, which makes computer flight simulators. The stock trades at six times earnings, has a 2.7% yield, and sells below book value. He also likes Piccadilly Cafeterias, a Southern restaurant chain, and Farmer Brothers, a West Coast coffee distributor. Joel Tillinghast, manager of Boston's $135 million Fidelity Low-Priced Stock Fund, is adding stocks that will be early beneficiaries of an economic recovery, like homebuilders Clayton Homes and Schult Homes. Another favorite is Baldwin Piano & Organ, which is a turnaround play. The company has cut costs, and earnings are bounding back. At only eight times earnings, Tillinghast says, it's selling for a song.

CHART: NOT AVAILABLE CREDIT: SOURCE: SMITH BARNEY CAPTION: SMALL STOCKS START TO SHINE Small stocks had been lagging behind the big boys, but now little companies like First Team Sports, which makes hot-selling Ultra-Wheels skates, are on a roll.