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Bottom of the Barrel: Small-Caps for Uncertain Times

At the brink of war, many readers have been asking which stocks in the Bottom of the Barrel portfolio will likely continue to work as the U.S. prepares for battle with Iraq.

Nobody knows what will happen once American soldiers are in harm's way. Almost everyone has an opinion, but war is uncertain by nature. Any predictions are based on probabilities, history and intelligence. And so my preferred small-cap strategy is to limit risk, focus on fundamentals and understand that the market's tenor will affect the direction of small-cap stocks.

The strategy is largely dictated by tenets of small-cap investing that I discussed in a January column. First, I want companies that show signs of moving toward profitability. Not every good small-cap idea will show earnings, but in times of uncertainty, I want companies that at least demonstrate earnings potential with honest management.

Second, today's most attractive small-caps are those with solid balance sheets. Given the precarious economic situation, I want more promises of balance sheet stewardship and fewer promissory notes. I also want simple stories: I want to be able to understand the product, the financials and the future.

It's not rocket science, but it's worth repeating when nerves can sometimes trump reason. With that in mind, here are some Barrel considerations as we move closer to war.

Energetic

I continue to like the stable of energy stocks in the Barrel portfolio. Although I think oil prices will settle in the mid-$20s and natural gas in the high $4 range, those levels are good for energy companies' earnings.

Therefore, I still like Energy Partners (EPL), a small-cap player in the Gulf of Mexico that posted an impressive discovery record last year. It appears to be off to a similar start in 2003. The market will recognize the companies that can find and deliver natural gas, as investors wake up and realize that supply is tight.

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