Making the Case for Small-Cap Stocks
Stock Market Analysis Video
In Case You Missed It
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A few weeks ago, I brought you the first part of a question-and-answer session with Cabot Small-Cap Confidential Editor Thomas Garrity. Today, I have the second half. Enjoy!
Question: What are your thoughts on the three-year anniversary of Cabot Small-Cap Confidential?
Answer: I’m feeling highly energized about the three-year anniversary of Cabot Small-Cap Confidential, especially when I think about our loyal readers. When we first started the newsletter, my goal was to share my proven investment strategy with subscribers. And we’ve done that and more. We know that readers have a choice about where to get their investment advice and we’ve always aimed to make Cabot Small-Cap Confidential the #1 choice for investors interested in that asset class.
We don’t piggyback on the hot stock of the day, but work to ferret out the next big stocks long before Wall Street has heard of them. We focus on stocks that follow the Law of Large Numbers and give our investments time to mature. We always seek to recommend companies that are on the cutting edge technologically, as that’s where small-cap fortunes are made! I’ve very much enjoyed sharing these ideas with readers over the last three years and look forward to many more.
Question: Where do you see the market, and small-cap stocks, for the rest of 2010?
Answer: Small-cap stocks as an investment class have traditionally been ignored because of their volatile nature and perceived risk, a phenomenon I see changing in the years ahead. It’s true that in times of business instability, investors are routinely unwilling to accept higher risk. When fear is the prevalent emotion, institutional and retail investors alike flee small-caps and put their money to work in large-caps, which are perceived as safer.
Unfortunately, despite the Fed’s accommodating monetary policy of the past two years, a broad economic recovery in the U.S. and around the world is unlikely right now. So an investment strategy directed at economically sensitive companies, like large-cap stocks, which may have historically driven equity market gains because of low interest rates and freer money supply, could now pose a higher risk.
I recommend investing in small-caps to capitalize on these challenges. Consider for a moment that companies routinely add to their workforces when they have confidence in the economic outlook. Job market numbers do not suggest that businesses are investing in human capital. I believe that companies are now working on getting the highest returns on their infrastructure investments in technology and equipment. Investing in technology can yield cost savings to the bottom line, while potentially moving a business forward. So recurring investments in technology to bring about change will be a major theme. Given this type of spending, small-cap companies should exceed market expectations in terms of investment performance. And I expect the Russell 2000 growth index to expand, approaching a 10% or 11% aggregate return for the entire year.
Question: What would you say to an investor who has been scared off by this summer’s volatile market?
Answer: My first piece of advice is that whenever you invest in the market, you need to assume some risk. This is true in all areas of investing, whether it’s saving for college or retirement. In my own experience observing the stock market for over 30 years, I’ve come to notice that everyday investors fail to invest monies when stocks are cheap and end up buying equities at their highest prices.
When you’re ready to put a toe in the water (hopefully now), the next thing to consider is the type of company you wish to invest your money in. Make certain that the company you plan to invest in has plenty of cash on the balance sheet. And look for evidence that this company has a business model and product that will prove successful for years to come.
Finally, you must decide how much of your money to invest in a given stock. Consider allocating some initial funds to the stock and gradually adding more based on news about the company, its competitors, its addressable markets and the degree to which the company’s financial operations (earnings performance and other metrics) exceed the criteria you had for making the investment in the first place.
Question: How does economic climate factor into your stock picks and outlook on the market?
Answer: Leadership is the watchword with respect to how economic factors influence my investment selection. I will always invest where technological change is defining the next generation of business opportunities and in those companies whose business models will likely exceed market expectations.
In short, invest in the company with the largest market share in a flourishing sector. Chances are if the company is top dog, it has the know-how to re-invent itself if necessary and already has products that are used by many customers. Because we choose dominant players, they typically have proprietary products that present barriers to entry for competitors. With such a presence, these companies tend to enjoy pricing power within their marketplace. In addition, we favor businesses that operate as though their revenues were an annuity payout. Whether they’re peddling a printer cartridge or a disposable medical catheter, cash resources available to invest in R&D for new products is always a concern. In summary, we’ll continue to recommend investments only in business niches where the Law of Large Numbers applies and the risk/reward scale is clearly skewed in the direction of high rewards.
Question: What are your favorite sectors right now?
Answer: You saved the best question for last! The themes I’m most interested in now are: home entertainment, data, mobility, alternative energy and medical breakthroughs.
In home entertainment, we’re looking at semiconductor companies that make it easier to process information faster, help content providers deliver more variety and enable content to be displayed in a new interactive medium. This is an area in which people spend a great deal of time and every content provider and technology company wants to make you happy and entertained at home. So it’s our job to find the semiconductor companies that will make that home entertainment experience cheap to deliver and maintain its popularity. For example, Cabot Small-Cap Confidential recommended a technology company that makes multi-threaded processors, which enable more applications to run from a device like the set-top box on your television.
Now, more than ever before, video content is clogging data networks, which is exciting to us because such circumstances create opportunities for investment. Companies that can unclog network pipes by enabling video dissemination in a cost-effective manner will be in high demand.
Another theme involves the popularity of mobile devices. The challenge now is that all of the applications running on these portable devices drain battery life. We’ll seek out companies that can lower the power requirements of mobile devices.
While the high price of oil and the pollution created from burning fossil fuels is a problem, the situation excites me. Alternative energy is another area we’re enjoying researching for investments. And in the field of medicine, we’re interested in telemedicine, electronic medical records and any drug or device that can reduce health care spending.
Please click here to learn more about investing in small-cap stocks and how to take advantage of our Limited Time Anniversary Price Rollback when you subscribe before October 1!
In this week’s Stock Market Analysis Video, Cabot China & Emerging Markets Report Editor Paul Goodwin says the stock market remains in a strong uptrend, but it’s still not time to get all the way invested. Paul says there is still a high level of anxiety among investors. Stocks discussed include: Lululemon Athletica (LULU), NetApp (NTAP), Rediff.com India (REDF) and Under Armour (UA).
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In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, I have links below to each issue.
On Monday, J. Royden Ward discussed the benefits of investing in stocks with companies based in Canada (but that trade on U.S. exchanges). Roy profiled two of the companies he thinks will do well in the next couple of years. Featured stocks: Gildan Activewear (GIL) and Silver Wheaton (SLW).
On Thursday, Paul Goodwin discussed why it’s near impossible to pick just one stock when readers ask, “If you could buy just one stock here, what would it be?” Paul also wrote about the recent news on rare earth elements and a speculative stock in the industry. Featured stock: Molycorp (MCP).
Until next time,
Editor of Cabot Wealth Advisory