Small Cap Investing: What A Bank Robber Can Teach You About Investing
by Marc Lichtenfeld, Senior Analyst, Smart Profits Report
Thursday, April 16, 2009
Want to get ahead in the investment world?
Just follow the advice of infamous bandit, Willie Sutton.
When asked why he robbed banks, Sutton had a ridiculously logical answer: “Because that’s where the money is.”
Duh.
While I wouldn’t suggest you follow Willie’s profession, you can use his logic when investing.
Question is: Where’s the money now?
Small Cap Investing - Leading The Way In 2009
Look no further than small-cap stocks…
Since the March 6 low, the Russell 2000 small-cap index has shot up by 34.6%. Compare that to the rise of 27.3% for the S&P 500 and 24.2% for the Dow Jones Industrials and you can see why small-caps get their reputation for leading the market out of recessions and bear markets.
- Historically speaking, small-caps outperform their larger-cap peers in both short timeframes and over the longer-term, too.
- In fact, from 1943 to 2007, small-caps outperformed large-cap stocks by over 50 percentage points in the three years after a recession.
- Breaking it down further, a glance at the top 50 performing stocks so far this year contains a disproportionate amount of small-cap names.
How disproportionate exactly?
Well, with 70% of the top 50 performers having market caps under $1 billion and 54% of them with market caps under $500 million, I’d say it’s a large majority.
Small Caps… Big Punch
It makes sense that a smaller stock has greater potential for larger moves. For one thing, it takes less buying volume to move a stock with a $300 million market cap than it does for a $30 billion name.
The big bonus for smart investors is that many of these smaller stocks receive less attention from Wall Street and the media. And that throws up some excellent opportunities.
- Take Dupont Fabros Technology (NYSE: DFT), for example - a company with a $150 million market cap. The stock was plodding along uneventfully until it reported strong earnings in February. Once Wall Street caught wind and issued an upgrade, shares jumped by 37% - and then went on to double in the next two months!
- Dendreon Corporation (Nasdaq: DNDN) saw an even bigger move. This $700 million market cap company skyrocketed by 132% on Tuesday after the firm released positive news on its prostate cancer drug, Provenge.
So what should you look for when small cap investing?
Small-Cap Investing 101: Big Growth… Plentiful Cash… Low Debt
Right now, investing in small cap stocks appears to be the flavor of the month - although that could change if the market re-tests its lows. In the meantime, watch for companies with strong growth prospects that will stand out in this recession.
For example, Calgon Carbon Corp. (NYSE: CCC) has a projected five-year earnings growth rate of 38%. That was a key factor when I recommended it in the Xcelerated Profits Report in February - and Wall Street loves it, too. Since then, the stock has shot up 42%.
Be sure that companies have cash and aren’t loaded with debt. Needless to say, it’s a tough environment to raise money. So you don’t want to hold a company that’s having trouble meeting its obligations. That’s especially true in the biotech sector, where smaller companies often don’t have any revenue at all.
Small Cap Stocks - Volatility vs. Profit Potential
Keep in mind that small-cap stocks have more risk and are therefore more volatile, so thorough due diligence is essential; while the profit potential may be huge, your fortunes can go both ways.
Just as a little extra volume can move these stocks sharply higher, this can also happen to the downside.
Then again, the entire market is subject to much greater volatility these days, with traditionally “safe” companies trading like penny stocks.
History has proven for decades that small-caps post the best performance coming out of bad times. It’s a market that gives you the best chance for truly explosive gains in both the short and longer term.
Marc Lichtenfeld
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