Saturday, June 26, 2010

3 Things People Miss When Looking for the Next Hot Small Cap

Every portfolio needs a strong foundation of stable and dependable investments. Solid income producers and tried and true equities are the hallmark of a prudent retirement plan.

But is that enough?

Those of us heading into retirement may have to do more with our portfolios if we expect them to support us in our golden years. And that's not that easy, especially when you consider that 
the S&P 500 lost -9.1% from 2000 to 2009.

But not all stocks had a lackluster performance.
Company (Ticker)2000-2009 Returns2000 Market Cap
Medifast (NYSE: MED)+9,244%$2 million
Green Mountain Coffee (Nasdaq: GMCR)+7,342%$27 million
XTO Energy (NYSE: XTO)+6,988%$427 million
Hansen Natural (Nasdaq: HANS)+6,563%$43 million
Bally Technologies (NYSE: BYI)+5,407%$31 million
Southwestern Energy (NYSE: SWN)+5,269%$165 million
Terra Nitrogen (NYSE: TNH)+4,752%$93 million
Contango Oil & Gas (AMEX: MCF)+4,452%$6 million
Clean Harbors (NYSE: CLH)+4,424%$14 million
Amedisys (Nasdaq: AMED)+4,208%$4 million

Notice something about these top performers? They all started as small caps. That unto itself should come as no surprise. Historically, small cap stocks outperform their larger, slower-moving, peers. In fact, the Russell 2000, the benchmark index for small-cap stocks, returned +41.6% from 2000 to 2009.
But with small caps' bigger returns come bigger risks. Plenty of small companies fail to slay the Goliaths of their industry. Despite the challenges, the decade's top performers overcame the odds -- and thrived. Why? Each had a unique driver to propel it.
Re-inventors: Green Mountain Coffee Roasters (Nasdaq: GMCR) started as a small cafe in Vermont in 1981. Over the years, it grew into a solid specialty gourmet coffee distributor. But in 2006, the company revolutionized its business by acquiring Keurig, a manufacturer of single-cup brewing systems.
People have been drinking coffee since the thirteenth century. But by delivering a unique delivery system, Green Mountain changed the industry's paradigm. They saw an opportunity that the big guys missed.
Netflix (Nasdaq: NFLX) was another David that slew Goliath by changing the industry paradigm.Blockbuster (NYSE: BBI) and Hollywood Video were huge companies with locations all over the country. But the little upstart Netflix started delivering videos and DVDs by mail -- and now directly to your TV via the Internet. People loved not driving to the store, settling for whatever was left on the shelves and not paying late fees.
Industry Wave Riders: Bally Manufacturing Company (NYSE: BYI) was founded in 1932, selling small cast-iron slot machines. The company first started trading on the New York Stock Exchange in 1975 with the ticker symbol "BLY." But believe me, you wouldn't have wanted to own it for all those years.
For decades, the casino gaming machine market was limited. But in 2000, the market began to explode. Las Vegas went through a decade-long expansion, while additional states legalized gambling as well. It seemed like every American Indian nation established a casino business. As the industry expanded, so did Bally's customer base.
Industries expand and contract for a myriad of reasons. But when a specific industry is on the upswing, it can turbo-charge the small caps within it.
Macroeconomic Money Makers
Global trade and a falling U.S. dollar set the stage for the ascent of fertilizer company Terra Nitrogen (NYSE: TNH). As the economies in China and India grew at breakneck speed, so did the size of their middle classes. With more disposable income, the demand for more food -- and specifically meat -- grew. It takes about 4.7 pounds of corn to yield 1.0 pound of edible beef. This shift, initially driven by increased global trade, increased the demand for grain.
Commodities are priced in U.S. dollars. If the dollar loses its relative value to other world currencies, the prices of commodities tend to compensate by rising. Between 2002 and the spring of 2008, the U.S. dollar lost -40% of its value, while commodity and fertilizer prices soared.
Sometimes small macroeconomic shifts can cause big shifts in the investment landscape. Knowing the effects of those shifts can help investors harness a small-cap winner.
Action to Take--> It wouldn't be prudent to devote a retirement portfolio to small caps. But just a few small gems can go a long way.
I currently have two small caps on my watch list. Deer Consumer Products (Nasdaq: DEER) is small Chinese kitchen appliance producer. As the Chinese middle class grows and the Chinese Yuan appreciates, this could be a strong performer. KMG Chemicals (Nasdaq: KMGB) is a small Houston-based chemical company. It specializes in the chemicals used to produce semi-conductors -- a sector that's rebounding with a vengeance.

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