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Small Caps: It’s Time to Think Small
by Louis Basenese, Advisory Panelist
Associate Investment Director, The Oxford Club
Wednesday, November 19, 2008: Issue #888
Over one million jobs vanished this year. Retail sales cratered for the eleventh consecutive month. Auto sales, and for that matter automakers, are headed for the junkyard. And there’s no sign of consumer confidence anywhere.
It’s not official yet. Apparently the committee of “esteemed” economists at the National Bureau of Economic Research (NBER) doesn’t get paid for timeliness. But the statistics don’t lie… we’re in a recession.
And that’s got me giddier than an Obama supporter scoring an inauguration ticket. That’s right. I’m actually glad the economic data stinks. Because when a recession is here, a small-cap rally isn’t far behind.
Accordingly, I’m loading up on small caps in my own portfolio. I suggest you do the same, instead of joining the lemmings piling into Treasuries.
If you’re reluctant and afraid small caps are too risky, chew on this:
In the year following the six major bear markets of the last century, small cap stocks soared an average of 82%, according to Ibbotson Associates.
If the prospect of an 82% gain doesn’t excite you in these trying markets, check your pulse. If it does, read on…
Any Old Small Cap Just Won’t Do
There’s no denying the strong historical trend, but it doesn’t mean ALL small caps will soar. Nothing in investing is ever that easy. In order to really benefit from the imminent rally, we need to isolate the most compelling and innovative small-cap stocks.
To that end, let me share a disciplined approach that’s always served me well. When it comes to small caps, I focus exclusively on companies with these three characteristics:
- A pioneer on the verge of creating new trends. Companies can create products to compete in existing markets… Or they can create products that are so revolutionary and timely that they launch their own markets and trends. The latter obviously positions the company, and in turn investors, to reap the most profits. If you need help qualifying this factor think Intuitive Surgical (Nasdaq: ISRG), Google (Nasdaq: GOOG), even VMware (NYSE: VMW).
- Within three years of an initial public offering (or major index listing). Smaller and/or newer companies have more room to grow. Plus, Wall Street tends to overlook many of these firms. By focusing on these young and virgin opportunities, we can actually profit ahead of the Wall Street institutions and the trillions in capital they control.
- Increasing earnings by at least 30%. A market panic can only hold back fast growing stocks for so long. Eventually, share prices will follow earnings. By focusing on companies with the strongest growth profiles, we set ourselves up for the most dramatic gains. And yes, even in this market such companies do exist.
Other characteristics worth screening for include: recurring revenue streams, potential applications for products in parallel markets, new products in the pipeline, little or no analyst coverage and management ownership of 10% or more.
Granted, the process of actually finding such companies is tedious and time consuming. But as Abraham Lincoln quipped, “Things [profits] may come to those who wait, but only the things [profits] left by those who hustle.”
In other words, all the hard work we put into indentifying these small-cap stocks will be rewarded. But if we don’t grab the profits while we can, another investor will.
Short on Time? Buy These 2 Small Caps… And Call Me in a Year
I recognize not all of us can scour the markets each day in search of the most compelling opportunities. So let me make it easy for you. Here are two small-cap companies I’m convinced will be 50% higher (or more) a year from now. [Editor's Note: To get all of Lou's small-cap recommendations, you can sign up here.]
- Genoptix, Inc. (Nasdaq: GXDX) The economic cycle doesn’t impact business for this provider of bone marrow and blood-based cancer tests one bit. Sadly, when it comes to diagnosing cancer, people can’t wait for better times. But the company’s focus on community-based oncologists also provides ample growth opportunities. Earnings increased 198% in the last nine months to $26 million. And yet, the company still only controls 4% of the market.
- American Public Education, Inc. (Nasdaq: APEI) This West Virginia-based company provides online, post-secondary education to a very specific market – military personnel. Its niche focus is delivering impressive growth, with revenues and earnings up 56% and 72%, respectively, in the most recent quarter.
Whether you opt for these recommendations or seek out your own, it doesn’t matter. A recession is here, so a small-cap rally isn’t far behind. Before it’s too late, I recommend you position yourself accordingly.
Good investing,
Lou Basenese
Editor’s Note: Lou’s so excited about the imminent small-cap rally that he’s launched a revolutionary newsletter that does nothing but focus on these explosive companies. Sign up to the White Cap Report to find out the five companies he’s recommending right now.
Today’s Investment U Crib Sheet
The financial industry traditionally uses small-, mid- and large-caps to describe and classify companies. But as investments have become increasingly specific, so have the definitions. These have expanded to include nano-, micro- and mega-caps.
| Market Capitalizations | |
|---|---|
| Nano Cap | Below $50 million |
| Micro Cap | $50 million to $300 million |
| Small Cap | $300 million to $2 billion |
| Mid Cap | $2 billion to $10 billion |
| Large Cap | $10 billion to $200 billion |
| Mega Capo | More than $200 billion |
To calculate a company’s capitalization, simply multiply the share price by the amount of shares is has. For example, a company with 10 million shares, trading at $50, has a capitalization of $500 million – making it a small cap. You can find this information through Google Finance or any other stock quote site.
As Lou mentioned above, small caps have a history of being some of the first stocks to move upward in a new bull market. Their size enables them to react, make changes and return to profitability faster than a large company can.
Imagine a large- or mega-cap company as an oil tanker and a small cap as a speedboat. You can picture how easy it would be for the small boat to change direction, and how hard it would be for big corporations.
If you’re trying to figure out when the market might begin to recover, take a look at last Wednesday’s column from Lou, where you’ll find the only indicator you should be keeping your eyes on.
- Small Cap Stocks: How to Find the Russell 2000 All Stars
- Pocketing Nice Dividends with Hot Small-Caps
- Small-Cap Stocks: The Most Important Trend Headed into 2009
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2 Responses to “Small Caps: It’s Time to Think Small”
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A former Wall Street consultant and analyst, Louis helped direct over $1 billion in institutional capital before joining forces with The Oxford Club.
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March 1st, 2009 at 10:05 am
I had some reserach and different people after
I had done the reasearch talked about just wanted to know your thoughts oc ICLK,RPTN,SPBU,VOYT.
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March 3rd, 2009 at 2:04 pm
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