Small can be beautiful, but unpredictable.
As an investor, you can spend time pondering the so-called “January effect” that often boosts prices of small-capitalization stocks more than any others early in the year.
You can compare small stocks to big stocks until your head aches. Small has outperformed large for several years, though admittedly most everything was down. You can also calculate the potential impact of new tax incentives or economic recovery on stocks of different size companies.
But in the end, small-cap stocks are just another piece of the investment puzzle and not the antidote for a bear market.
The best that can be said is that small stocks are likely to perform better than big stocks again this year. In the move toward portfolio diversification, it’s sensible to take a second look at these downtrodden little guys.
“The January effect came early when the stock market rebounded from Oct. 9 through Nov. 30, as beaten-up smaller small-caps bounced back,” noted Steven DeSanctis, director of small-cap research for Prudential Securities. “But small caps should outperform large caps in 2003 because an improving economy tends to benefit them the most, giving them better earnings than large caps.”
Small caps usually outperform large caps over a six-year cycle, DeSanctis pointed out, and “we’re coming up on our fourth year of outperformance.”
Not all small caps are alike. Small-cap value stocks, those shares deemed cheap in light of future potential, lost 14.5 percent in 2002. Small-cap growth stocks, aggressively selected for price appreciation, tumbled 32.3 percent.
“When we get through 2003 and look back, small-cap, high-tech growth companies will have turned in a good performance,” said Jim Collins, editor of the OTC Insight newsletter (www.otcinsight.com) in Walnut Creek, Calif.
Collins favors J2Global Communications (JCOM) in Web conference calling and voicemail; Biosite (BSTE), maker of antibody-based diagnostic tests used in hospital emergency rooms; specialty pet store PETsMART (PETM); Canada’s Glamis Gold (GLG), which operates mines in the U.S. and Central America; and specialty clothing retailer Chicos (CHS).
Successful small-cap funds employ many different strategies.
“Our small-cap investing is extreme, with breathtakingly small companies that have market capitalizations of $122 million or less, which is an asset class that just had a stellar year considering that it was a bear market,” said John Montgomery, who manages Bridgeway Ultra Small Company Fund, which has a three-year annualized return of 14.24 percent. “Four years of a bear market would be unusual, though that doesn’t mean we’ve touched bottom.”
More Top Picks Best Large Print E Readers For Elderly
Montgomery’s best stocks have been online company SINA Corp. (SINA), information service provider for China that gained 330 percent last year; and environmental services firm Clean Harbors Inc. (CLHB), whose treatment of industrial and household waste led to a 215 percent gain.
“We try to buy businesses with a high rate of return on the owner’s capital, terrific business managers and excess profits that can be reinvested,” explained Charles Akre Jr., manager of FBR Small Cap Value “A,” which has had a three-year annualized return of 9.03 percent by investing in stocks with market capitalizations of less than $1 billion. “We don’t want to pay much for these companies.”
Akre’s top holdings are specialty insurer Markel Corp. (MKL) in niche property/casualty markets not as highly regulated as standard lines, and Penn National Gaming (PENN), which owns horse tracks and off-track wagering facilities.
The top small-cap stock funds the past 12 months, according to Morningstar Inc., have been:
– Royce Special Equity (RYSEX), $219 million in assets; “no load” (no sales charge); $2,000 minimum initial investment; 800-221-4268; three-year annualized return 21 percent; up 21.09 percent.
– Schroder Ultra (SMCFX); $215 million; no load; $10,000 minimum; 800-464-3108; three-year annualized return 69 percent; up 11.54 percent.
– Bridgeway Ultra Small Company (BRUSX); $59 million; no load; $2,000 minimum; 800-661-3550; three-year annualized return 14 percent; up 5.62 percent.
– FBR Small Cap Value “A” (FBRVX); $29 million; no load; $2,000 minimum; 888-888-0025; three-year annualized return 9 percent; up 5.22 percent.
– PIMCO NFJ Small Cap Value “A” (PCVAX); $406 million; 5.5 percent load; $2,500 minimum; 888-877-4626; three-year annualized return 15.41 percent; up 3.62 percent.