*** James Boric reports from South Adams St. in beautiful Bloomington, Ind….

*** The IPO market is heating up, my small-cap friends. In fact, it’s on a record pace. The main headline in USA TODAY’s Tech section yesterday read, “IPOs in 2005 Raise Record $8.4 Billion.”

The article went on to say…

“As of Wednesday, initial public offerings have raised $8.4 billion, an all-time high for this early in a year, Thomson Financial says. It even tops the $7.6 billion raised by IPOs during the same period of 2000. That’s quite an accomplishment considering it was this time five years ago when the dot-com IPO boom was humming.”

Quite an accomplishment, indeed. But beware…

I’ve been warning everyone that the hot IPO market could be a foreshadowing of what’s to come for a lot of overpriced small-cap stocks. The last time there was such a rush to bring new companies to market was in 2000 — and we all know what happened then: It tanked.

But I wouldn’t lose any sleep over it…

While the market may be ripe for some profit-taking in 2005, I don’t expect a total collapse like five years ago. It’ll be gentler. You see, investors have gotten a little smarter this time around.

During the mighty tech boom of the 1990s, 60% of the companies that IPOed were technology based. And the average age of those companies was only four years old. (No wonder they failed miserably: They were toddler companies in a mature market. Of course they were gonna fail!)

This time around, only about 20% of the new IPOs are tech based. And the average company going public is eight years old — twice that of their 1999 counterparts.

While the hot IPO market of 2005 doesn’t have “rip-off” written all over it, I would still beware. Historically, the only people who make money during an IPO are the underwriters and the owners. The rest of us usually end up taking it on the chin.

I bet the same holds true in 2005. We’ll have to see.

*** For now, I did a scan of the most ridiculously priced small-cap stocks on the market — in terms of price to book, price to sales and earnings. These are my candidates to tank if the IPO market is indeed a foreshadowing of a possible small-cap bubble. Here are the top 10 worst companies on the market today…

#10) Telkonet, Inc. (TKO:AMEX): P/S: 309, P/B: 64, -$0.34 EPS
#9) Immtech Intl., Inc. (IMM:AMEX): P/S: 41, P/B: 613, -$1.51 EPS
#8) Samaritan Pharmaceuticals, Inc. (LIV:AMEX): P/S: 423, P/B: 306, -$0.06 EPS
#7) CoraUtus Genetics, Inc. (VEGF:NASDAQ): P/S: 743, P/B: 22, -$0.72 EPS
#6) Interactive Systems (ISWI:NASDAQ): P/S: 938, P/B: 30, -$0.68 EPS
#5) MicroIslet, Inc. (MII:AMEX): P/S: 975, P/B: 87, -$0.15 EPS
#4) Marshall Edwards, Inc. (MSHL:NASDAQ): P/S: 2,096, P/B: 22, -$0.16 EPS
#3) Endeavour Intl. Corp. (END:AMEX): P/S: 6,459, P/B: 44, -$0.56 EPS
#2) Mines Management, Inc. (MGN:AMEX): P/S: 7,943, P/B: 26, -$0.25 EPS

And the single worst small-cap stock on the market…

#1) KFx, Inc. (KFX:AMEX): P/S: 27,047, P/B: 25, -$0.11 EPS

*** Speaking of bubbles, our very own Sala Kannan just returned home from India — where she is from. Sala and I chatted for a long time yesterday. And she couldn’t stop talking about the housing market in India:

“While I was in India, I was looking around for investment opportunities. My investigations bought me to a real estate broker in the city of Chennai.

“The broker took my husband and me to look at some land on the beach. I was excited at first. But when we arrived, the land hardly had ‘Southern California’ written on it. The plot of land was small, muddy and very uneven. Still, our broker told us, ‘Someone even bought that!’

“If the word ‘bubble’ comes to mind, think again. We often mistake a robust market for a bubble. Let me tell you, the market in India is robust right now. And a small-cap investor can make a lot of money in a robust market. How?

“Three words: Own the banks! As more and more people buy homes, they will be taking out loans — lots of loans. That means the banks will surge in the coming months and years.

“The only Indian bank that trades in the United States is HDFC Bank Ltd. (HDB:NYSE). In the last year, shares are up 45.3% — rising from $30.96 to $45 yesterday. But the real sizzle was in some of the Tier 2 banks, such as Allahabad Bank, Andhra Bank, Karnataka Bank and Federal Bank. They have risen as much as 133%, 70% and 77% in the past year.

“Of course, you can’t invest in those in the U.S. You would have to open up an account in India — which can be tricky. But I have to say, it might be worth it. In fact, I am working on a report right now that will show investors how to do just that — invest in Indian companies that don’t trade as ADRs here in the United States.”

(For the record, ADR means American Depositary Receipts.  They are receipts for the shares of foreign-based corporations held in a U.S. vault.  This saves investors the hassle of trying to buy shares in overseas markets.)

*** Sala reminds me of one of our 2005 small-cap predictions…

Emerging markets like India will continue to outpace the U.S. markets.

In the last year, India’s main stock index, the Sensex, is up 17.7%, while the Dow Jones is only up 0.32% and the S&P 500 is up 3.7%. Not bad. And if you are a Penny Stock Fortunes reader, you may recall I recommended two Indian telecom stocks well over a year ago — to take advantage of the Indian boom.

Shares of long-distance provider Videsh Sanchar Nigam Ltd. (VSL:NYSE) are up 24.8%. And shares of telecom services mogul, Mahanagar Telephone Nigam Ltd. (MTE:NYSE), are down 6.3%.

If India continues in its rapid growth phase, I expect both VSL and MTE will be good investment opportunities. And there is reason to believe the telecom industry will continue to grow.

*** India’s government recently opened its telecom companies up to more competition and more outside money by raising the foreign ownership level from 49% to 74%. As a result, I expect a surge of interest in Indian phone companies in the coming months and years from foreign investors — at least that would make sense. India has become the world’s second fastest growing wireless phone market with a target of adding 200-250 million wireless phones by 2007, compared with approximately 95 million now.

That’s growth!

*** As a hard-nosed analyst, you’d never think that Sala is into teddy bears.  And of course, she’s found a way to make a bundle off them…

Bullish on Teddy Bears

I’m bullish on bears. The stuffed, cuddly kind. If you’ve ever walked into a Build-A-Bear Workshop, you know what I mean.

It is virtually a teddy-bear heaven for kids. A child can pick out a skin for her teddy bear and watch it being stuffed. After a “hug test,” the child can pick out clothes, shoes and accessories for her new bear.

The child can also put a wish or voice message inside her toy. She even gets a bar code linked to her teddy bear, in case it gets lost. This sort of customization is fascinating not only to the company’s young customers, but also to much older investors.

The rage on Wall Street right now is retail customization — companies that can successfully carve out a popular niche in America’s $31.2 billion toy market.

For example…

Small-cap companies like Build-A-Bear and Vermont Teddy Bear Co. offer such customization — and exciting returns to investors. Vermont Teddy Bear Co. stock rose 44% in 2004, and Build-A-Bear saw a 58% increase in stock price since its IPO in November 2004 — going from $23.55 to a high of $36.95.

The reason for these stellar returns?

Because in a marketplace dominated by high volume and low-tech gimmickry, Build-A-Bear and Vermont Teddy Bear Co. provide something truly unique: exclusivity. Although everyone chooses from the same menagerie of animals and accessories, each is created by its owner. So whether it’s a bear, dog, horse or monkey, the new owner becomes immediately attached to their stuffed toy.

Such customization and attention to detail is possible only in small-cap companies. If they need to compete with the heavyweights like Mattel, they have to innovate. Experience-centered retail adds value and innovation to a business. The $100 that a parent spends for his child at Build-A-Bear Workshop is not just for the stuffed toy, but also for the experience of putting together one’s own teddy bear.

In marketing lingo, this experience is called “retailtainment.” It’s a concept exclusive to small caps – at least in the teddy bear business. “Retailtainment” is a powerful tool for growth — and because it accelerates customer loyalty, it also erects formidable barriers to entry.

Ben McConnell and Jackie Huba have written a book about this concept — Creating Customer Evangelists: How Loyal Customers Become a Volunteer Sales Force. Build-S-Bear Workshop is a featured case study of how the company offers such a unique mass customization experience that its customers evangelize it.

Innovation is taken so seriously that at Build-A-Bear, Chairman and CEO Maxine Clark is actually known as the CEB, or chief executive bear. The company also has a chief operating bear, chief financial bear and chief marketing bear.

Vermont Teddy Bear Co. is also innovating. It has a pajama division through which customers can buy and send sleepwear and spa products. The company is also trying direct marketing and targeting women.

The innovative ideas have definitely paid off. Vermont Teddy Bear Co.’s revenue increased 38.7% last year. The company has a gross profit margin of 57.2%. It also has very low debt, with a debt-to-equity ratio of just 0.75.

Newcomer Build-A-Bear Workshop grew earnings per share last quarter 296% over the same quarter a year ago. To top it off, the company has absolutely no debt. Analysts expect the company to grow 25% next year.

And that makes sense…

With 64 million children in the U.S., their average expenditure per child is $488. So that means these are bears the bulls can love.

Have a profitable day,

Sala Kannan

February 18, 2005

James Boric

James Boric began his finance career by successfully picking winning stocks. With time and experience, James realized his goal- to figure out how an average, everyday investor with little capital could become wealthy. The trick, he discovered, was to look to the quickest moving, most exciting and lucrative group of stocks in Wall Street history — small-caps.

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