Bottom of the Barrel: Explaining Small-Cap Methodology

Moreover, it always pays to look for secondary plays on a theme, especially in small-caps. In this case, I looked at Maverick Tube (MVK Quote), a maker of drill pipe that's sold to those searching for natural gas and oil. It only made sense that if more wells were going to be drilled, more drill pipe would be needed. Also, drill pipe would be sold before the wells were actually drilled, making Maverick an early-cycle beneficiary of the trend.

Indeed, Maverick is up nearly 40% since its profile in January. Although the company preannounced a weaker-than-expected second quarter Monday and is issuing convertible debt, it remains an interesting proxy for the expected pickup in the energy sector. But at these prices, I'm not as enthusiastic as I was in January.

Another strategy that has worked well is developing a portfolio of small-cap stocks that pay healthy dividends. With the new dividend tax cut and investors growing more focused on current yield than on growth, dividend stocks have performed well. A number of the stocks profiled -- Hawaiian Electric (HE Quote) and Acadia Realty (AKR Quote) come to mind -- have been solid performers largely because they have solid dividend yields. Again, this macro trend is providing support for small-cap names that fit the bill.

There's a look under the hood of the Bottom of the Barrel process. It's not rocket science, but an amalgamation of information, research, discipline and common sense. Next week, I'll review the portfolio's names and do a semiannual housecleaning. Then it's back to the stock-picking process.