Micro-Caps Now Give 'Bang for Your Buck'

NEW YORK (TheStreet) -- Volatility in the stock market has investors running for blue-chip stocks, but the best risk-reward proposition lies in smaller companies, says Sam Dedio, manager of the Artio U.S. Microcap Fund (JMCAX). The investor favors tiny tech stocks including Network Engines (NEI) and Integrated Silicon Solution (ISSI).

The mutual fund, which garners two of five stars from Morningstar ( MORN), has returned 24% over the past year, compared with 18% for its peers. During the past three years, the fund has risen an average of 4.9% annually, whereas its rivals are little changed.

Why are micro-caps a good place to be now? Why not stick with large-caps?

Dedio: Blue-chips are safer but the risk-reward is certainly higher with micro-caps. And given the fall they've had, the Russell Micro-cap Index is underperforming the Russell 2000 year-to-date by about 300 basis points. So the smallest caps have fallen the most, so that's where the opportunity is. You get more bang for your buck there, but you have to have the risk tolerance.

One stock in your portfolio is Network Engines, a data-storage company. Is storage still hot?

Dedio: Storage still is hot. Video is really intensive on the networks, it takes a lot of capacity and companies are doing a lot more online videos. This company really is a consultant company that allows software developers to get their programs and their applications up and running in a cloud environment much more quickly. The stock trades at about $1.20 a share. And that's currently below tangible book value. The company also has about $0.35 a share in cash so if you remove the cash, it trades at about 3 .5 times earnings, so it's one of the cheapest stocks I have in my portfolio.

Another tech name in your portfolio is Integrated Silicon Solution, or ISSI, which specializes in DRAM. Where is the DRAM market now?

Dedio: Price performance is really what matters in technology. And to gain price performance, a lot of companies have created hardware and software solutions that utilize DRAM and SRAM. This company is a beneficiary of that. A few years ago, the company was 50% levered to the consumer. Now the consumer is only 26% of their business so it's really a diversification story. And when you back out the $3 a share in cash it has on the balance sheet, it trades at 3.5 times earnings so it's another very cheap technology stock.

You own Morton's Restaurant Group (MRT) in your portfolio, but are people going to be eating expensive steak dinners if we get a double-dip recession?

Dedio: The consumer might slow their steak purchases, as we learned in the recession in 2008 and 2009. However, Morton's survived and the brand stayed intact. The downturn didn't really tarnish their service or their brand. They didn't offer specials to reduce their value proposition. They kept pricing firm. And they continue to attract the high-end diner. Corporate expenses are allowing diners to go out again and spend for entertaining clients. And consumers are also slowly coming out of the woodwork to go out to eat for specials occasions. Finally, the company has announced that it is for sale, so we are expecting a transaction to occur.

Lazard (LAZ) isn't a micro-cap, but it's small relative to other financials. Why do you want to own Lazard?

Dedio: About half of Lazard's business is advisory, so it's levered to M&A, which is heating up. In fact, Lazard advised Google on its Motorola transaction. The other half of their business is asset management, and that business actually has assets under management that are greater now than prior to the stock market's peak in 2007. And finally, it's trading at huge discount to its long-term valuation multiples.

-- Reported by Gregg Greenberg in New York.

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