Best Micro-Cap Funds Pay Off Big-Time

BOSTON (TheStreet) -- Investors bullish on prospects for a stronger economy next year have been buying everything from commodities and currencies to junk bonds and small-cap stocks.

They could go one step further and investigate mutual funds that own tiny companies that cost less than $10 a share. That means micro-cap funds.

Micro-cap fund managers seek bargain-priced stocks that may become the next Apple ( AAPL), which now trades at $321 a share. The maker of the iPad and iPhone, once a micro-cap stock, now has a market value of $294 billion. Sometimes micro-caps amount to total losses, a rare occurrence in the large-cap category.

The micro-cap stock label is used loosely to describe publicly traded companies with market capitalizations of $50 million to $300 million.

Indicative of investor interest in these smaller stocks, the various categories of small-cap funds as tracked by Morningstar have a return of 25% this year, versus the 13% gain by all categories of large-cap funds.

And the pace has been picking up. The Russell 2000 Index, which gives a wide measure of small-cap market activity, is up about 9.7% since the end of October, double the Standard & Poor's 500 Index's 4.4% gain.

Micro-cap investing has a Wild West reputation, and, indeed, it's the most volatile sector of the market, but some funds have long-term returns that match those of some of the most conservative investments.

For example, the Perritt Micro Cap Opportunities Fund ( PRCGX) has a 14% 10-year annualized return, while the Wasatch Micro Cap Fund ( WMICX) has an 11% gain. The S&P 500, in contrast, has dropped 9% since December 2000.

Here are some highly rated funds with micro-cap holdings and a few of their stocks trading for under $10 a share:

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Catalyst Value Fund ( CTVAX), $73 million in assets, a return of 16.3% this year and a 14% three-year annualized return, a performance that earned it a five-star rating (the highest) from Morningstar.

The fund throws out a big net in searching for prospects, and, as a result, has some particularly small stocks in its portfolio. Its top five holdings are: IDT ( IDT) , 9.6%; Global Ship Lease ( GSL), 8%; EBIX ( EBIX), 7.7%, GSI, 7.3%; and China MediaExpress ( CCME), 6%.

Global Ship Lease ( GSL), 8% of the fund; price: $4.94; up 244% this year; market cap: $272 million. Global Ship Lease is a container-ship-leasing company that buys vessels and charters them to container-shipping companies. Revenue for the nine months ended Sept. 30 was $118.8 million, up 9% from a year earlier, but it posted a net loss of $5.2 million, or 10 cents a share. Catalyst Value owns 3% of the company's outstanding shares.

Reading International ( RDI), 5.8% of fund; price: $4.97; up 23% this year; market cap: $116 million.

The company owns and manages commercial real estate and agricultural properties, in particular a number of theaters that provide live entertainment. It has a forward price-to-earnings ratio of 16.4. For the nine months through Sept. 30, it reported a net loss of $12.1 million, which includes a tax settlement charge of that amount.

Cinedigm Digital Cinema ( CIDM), 1.3% of the fund; price: $1.47; up 20% this year; market cap: $46 million.

The company's technology enables movie theaters and others to transfer film to digital-film formats. It has a technology used to deliver digital movies and other content via satellite or fiber-optic cable. In the first half of its fiscal year through Sept. 30, it reported revenue of $38.2 million, a 13% increase from a year earlier, and a loss of $18 million, or 60 cents a share.

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Perritt Micro Cap Opportunities Fund ( PRCGX), with assets of $421 million, a return of 23% this year and a 14% annualized return over 10 years. It has a four-star rating from Morningstar.

Its top five stocks are: Gulfport Energy ( GPOR), Questor Pharmaceuticals ( QCOR), Newpark Resources ( NR), Rentrak ( RENT) and Oplink Communications ( OPLK).

It has three stocks trading around $5 a share in its top 25 stocks:

BioScrip ( BIOS), 1.1% of the fund; price: $5.09; down 40% this year; market cap: $270 million.

The company provides services aimed at lowering pharmacy costs for corporate health plans by negotiating with pharmacy plan sponsors and health-care providers. It posted revenue growth of 13% and earnings per share of 95 cents in its most recent quarter. Its price-to-earnings ratio is 5.5 versus 15.4 for the industry. It has 66% institutional ownership.

Star Gas Partners ( SGU), 1% of the fund; price: $5.25; up 27.3% this year; market cap: $354 million.

The company is a distributor of home heating oil and offers related services such as heating and air conditioning system installations. It primarily serves the Northeast and Mid-Atlantic states. Star Gas Partners reported revenue of $1.2 billion and net income of $28.3 million for its fiscal year ended Sept. 30. It made several acquisitions in the past year to expand its territory. Perritt is the largest single outside investor in the company with a 1.1% stake.

Gilat Satellite Networks ( GILT), 1% of the fund; price, $5.22, up 11% this year; market cap: $211 million. The company provides Internet Protocol (IP)-based digital satellite communication and networking products and services worldwide. Its customers include the U.S. Postal Service and many cable and Internet companies. Net income for the nine months through Sept. 30 was $35.5 million compared with $1.5 million a year earlier, although revenue slipped slightly. Perritt is the second-largest institutional investor, owning 1.5% of outstanding shares.

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The Wasatch Micro Cap Fund ( WMICX) has assets of $325 million and a return of 26% this year, and a 10-year annualized return of 11%.

Its top five stocks are: Power Integrations ( POWI), 3% of the fund; CorVel ( CRVL), 2.6%; Dollar Financial ( DLLR), 2.4%; OPNET Technologies ( OPNT), 2.1%; Hibbett Sports ( HIBB), 2.1%.

O2Micro International ( OIIM), 1.9% of the fund; price: $5.62; down 8.6% this year; market cap: $188 million.

The company designs and develops analog products and various mixed-signal chips, which combine analog and other functions on a single integrated circuit. O2Micro gets about two-thirds of its revenue from sales of chips that power backlighting applications in computers and consumer electronics. Its customers include: Apple ( AAPL) and Hewlett-Packard ( HPQ).

O2Micro's trailing price-to-earnings ratio is 12.2 versus the 14.6 average of the Standard & Poor's 500 stocks. The Wasatch Funds family has a reputation for coming up with small-cap winners, and in this case, it appears the firm is sold on O2 Micro, as three Wasatch funds have stakes in this company, for a combined 8% of outstanding shares, the largest holding by an investor group.

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Managers Micro Cap ( MMCFX), with a three-star rating from Morningstar, assets of $146 million and a 27% return this year, has one stock under $7 in its top 25 holdings: Casual Male Retail Group ( CMRG).

Its top five holdings are: Spectrum Control ( SPEC), 1.4%; LaBarge ( LB), 1.2%; Columbus McKinnon ( CMCO), 1.1%; True Religion Apparel ( TRLG), 1.1%; and AZZ ( AZZ), 1.1%.

Casual Male Retail Group ( CMRG), 0.8% of the fund; price: $4.95; up 113% this year; market cap: $237 million.

The company is the largest retailer of men's big-and-tall clothing. It operates over 500 stores, throughout North America and England, as well as a direct-to-consumer business, and two Web sites. Institutional investors own 81% of its outstanding shares. For the nine months through October, it reported earnings of 21 cents a share, compared with 6 cents last year.

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Schneider Small Cap Value ( SCMVX), with assets of $94 million and a two-star rating from Morningstar, is up 26% this year and has a 10-year annualized return of 13%. Known as an aggressive fund that does its own fundamental research, its portfolio includes stocks with a wide range of prices and market capitalizations.

Its top five holdings and weightings are: Arch Coal ( ACI), 8.3%; Cloud Peak Energy ( CLD), 6.4%; Meritage Homes ( MTH), 5.3%; Axcelis Technologies ( ACLS), 4.3%; and Regional Financial ( RF), 3.3%.

ModusLink Global Solutions ( MLNK), 1.7% of the fund; price: $6.92, down 27% this year; market cap: $303 million.

The company is focused on e-commerce for businesses, including supply-chain management and marketing-distribution services. In its most recent fiscal quarter, it reported a net loss of $6.7 million, compared with net income of $8.6 million in the same quarter last year.

Axcelis Technologies ( ACLS), 4.3% of the fund; price: $3.34; up 114% this year; market cap: $362 million.

The company also makes equipment used in the manufacture of semiconductors. Several big computer-chip makers are its customers, including Samsung Electronics. It has a forward price-to-earnings ratio of 16.4. It recently reported third quarter revenue of $75.1 million, up 29% from the prior quarter and a net loss of $6.3 million, or 6 cents a share.

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