Big Secrets of Small Stocks

Readers of this column know that I’ve written about the scarcity of great investment opportunities in the stock market this year. In 2006, great stocks were coming across my desk every week. The number of great new opportunities is less this year as compared to last, but finally, this is starting to change.

What I’m finding now are really attractive micro-cap companies. Three companies I recently discovered could even be called super- micro caps with market capitalizations below $100 million. I’ve always liked small public companies. A business has to start somewhere. It’s really great to see a company develop over time. Usually, the investing time horizon is longer with small companies, but the payoff can be big (and so can the loss).

One thing I’ve noticed over the years is the affinity that individual investors have for small companies. Most individual investors like penny stocks, which the Street often refers to as stocks trading below $5.00 per share.

Companies don’t go public at prices below $5.00 per share. Usually the lowest price a company will list its stock for is around $10.00 per share. So this means that stocks trading below $5.00 per share are usually doing so because there have been some problems with the business.

In my experience, individual investors can’t resist low-priced stocks because there’s a perception that the capital gains could be bigger. Nothing could be further from the truth. Although not scientific, my view is that a $20.00-per-share stock is much more likely to double to $40.00 per share, then a $2.00 stock is to grow to $4.00 per share. And don’t forget that most institutional investors don’t touch penny stocks because there isn’t the liquidity to make it worth their while.

Still, there is good investment opportunity in any part of the stock market. Like I said, I recently identified three attractive new companies whose stock prices trade between $1.00 and $3.00 per share. If you are an individual investor who likes to speculate in penny stocks, just keep in mind that the vast majority of opportunities are turnaround situations. With this in mind, small companies are known for their resilience and ability to adapt quickly to changing conditions. No sector of the stock market is better at crisis management and honing its business plans.