A remarkable event is happening in the market -- small-cap value investors have been making excellent money. You remember small-cap. It's what no one does anymore. It's the sure path to investor hell. Well, maybe no longer.
A small-company value investor who runs a multibillion-dollar hedge fund, for example, was up 9% at the end of May. In the same period, the
Dow was down 8%, the
S&P had lost 3% and the
had been sheared 5%. Any way you look at it, this guy has been beating the market. You want "outperformance?" He's 17 percentage points ahead of the Dow, 12 above the S&P and 14 better than the Russell.
How's June? "We're having a very good month so far," the investor says.
His improved performance has been building for about a year.
He's not unique. A bunch of funds like his have been performing well. Small-cap value funds have left most other funds in the dust so far this year, according to
. This mutual-fund data provider reports that the average small-cap value fund has risen nearly 6% this year through the first week of June. In contrast, the typical large-cap growth fund is up a mere 1%; science and technology up 3% and telecommunications down about 2%.
"Small-cap value? Yeah right," you might be saying right about now. "This is the New Economy, baby. Gimme tech. Gimme global reach. Don't gimme the Old Economy's small dogs."
If you want to make money, you should remain open to more than one investment approach. Be eclectic.
The main reason the pros specialize, after all, is that it helps them market their services to pension and endowment funds. The only investor
have to convince is yourself. No one is going to second-guess you about buying large-cap high-tech and small-cap value.
And right now, small-cap value can work. The growth rates may be less than
. The technology is 20th century. But, the management is not Stanford Business School. But some of these companies are priced for extinction. For the investor to profit, all these companies have to do is survive.
Rear-echelon companies have a way of hanging on a lot longer than you might think. (Newspapers, for example, remained good businesses decades after they were supposed to have been put six feet under by television.) Good managers -- sometimes even mediocre executives -- find ways to survive changing times.
A Wall Street analyst may tout a new technology as "revolutionary." And it may be. But that does not necessarily mean that every low-tech company in the real economy is about to go the way of all flesh, even if the stock market has priced it that way.
Think of yourself as a fisherman in a skiff and small companies as the fish in the shallows. These are companies you can get to know well by reading their public filings. You can even get the attention of their investor relations people who are often ignored by the crowd. The businesses are generally not that complex. And you can get a good-sized position without moving the market, unlike institutional investors who need the liquidity of large-cap stocks.
Look Before You Leap!
But, watch out.
Low-priced small companies can have warts. They may often be "growth" companies that missed quarterly earnings expectations. In that case, the stocks were slaughtered and now trade at about 10 times earnings or less no matter how high the prior multiples.
Here is a typical example --
. A finance company, Finova lends money to mid-sized companies. On March 27, the company announced that it would not meet its first-quarter earnings estimates. It took an $80 million charge to earnings to bolster its loan-loss reserves and pay its departing CEO's severance package. The same day,
cut its buy rating on the company. The stock dropped 35% that day to close at 20 3/4. It bottomed on May 10 at 8 1/2. It currently trades around 13 1/2. No one cares that the company has a 17% annual revenue growth rate.
What, you might ask, is to like?
"It's got lots of problems," says one hedge fund manager who bought all the stock he could between 10 and 13. "But if the company is viable, it's a $25 stock down from $45."
He notes that company insiders have been buying the stock recently, that the basic business could be turned around and, most importantly to him, that the company is not going out of business.
recently issued a report on the company suggesting that Finova is likely to be sold. And some experienced bottom-fishers like
David J. Greene & Co.
have taken positions in Finova this year.
The point here is not to tout Finova but to make a more general point. There is opportunity among the wreckage in some small-cap stocks. It does require that you do your own research. Read the
filings. Check the news. Scan the analysts' reports. All this can be done by a motivated individual investor. Lots of this information is available on the Web, at
If that is too much work, then check out a good small-cap mutual fund. The top five such funds according to
DLB Micro Capitalization,
Strong Small-cap Value,
Third Avenue Value and
Boston Partners Small-Cap Value
When asked whether small-cap was a good place for the little guy to cast a net in this stormy market, the investment manager quoted at the top of this story said, "Could be."
That sounds a lot like "Yes."
Ian McDonald contributed to this story.