Ever since the Russell 2000 took a hit in May, a lot of money has been flowing into large-cap stocks. Meanwhile, the Dow Jones Industrial has soared while the Russell 2000 and the NASDAQ have lagged behind.

That’s the whole story as far as most investors are concerned. There has been a lot of chatter in the media lately about the return of blue-chip dominance, even though the Russell 2000 still posted a gain of more than 18% in 2006.

One particular Associated Press headline caught my eye a few weeks ago. It read: “Signs Point to Good Year for Investing in Large-Cap Stocks.”

The article says it might be time for small-cap investors to rethink their stock picking strategy. The author thinks this year, the best bet for anyone with a dime in his pocket will be the big-name stocks. The logic is that eventually, large-cap, blue chip returns must have a special year where they whip the Russell 2000—a benchmark group of 2000 stable small-cap stocks with proven, long-term performance.

This could be true. After all, the Russell 2000 posted a gain of more than 18% for 2006, officially beating the Russell 1000 Large-Cap Index for seven of the last eight years. However, the Russell 1000 caught a second wind and slammed the Russell 2000 for the second half of 2006.

The blue chips could slap around the Russell 2000 any given year. Whether or not this happens is none of our concern…

Our attention should not be fixed on the index as a whole, but rather on the individual companies we look to for profit potential.

For the first two months of 2007, some big-name stocks have performed quite well. Three members of the Dow Jones Industrials are showing double-digit gains so far in 2007: General Motors, Alcoa and Caterpillar (up 18%, 16% and 10%, respectively).

And while these early returns are nothing to scoff at, they hardly compare to the best performing smaller stocks. Take a look at some of the best performers of the Russell 2000:

Molecular Devices Corp (MDDC): This medical instruments maker received a huge boost in its share price in late January when drug developer MDS Inc. announced it was buying the company for $615 million.

MDS agreed to pay $35.50 per share for Molecular Devices, approximately 50% more than its then-current price of about $23.80 a share.

Hansen Medical Inc. (HNSN): Here’s another medical device company for you. This one develops robotics designed to position catheters. Just this month, Hansen submitted data to the FDA from a successful patient trial of its new products.

January 3 was the last time this stock closed under $12. As of this morning, shares of Hansen Medical were trading around $17.65—that’s more than a 60% gain in less than two months.

Zoltek Companies Inc. (ZOLT): Zoltek manufactures a new, futuristic carbon fiber that is 100 times stronger than steel. It beat estimates earlier this month, and continues to post solid gains. As reported on Forbes.com, Zoltek controls 85% of the market for aircraft brakes, and BMW is experimenting with car parts made of the company’s carbon fiber.

Zoltek was trading for less than $20 a share at the beginning of January. As I type, it is up more than 1.3% this morning to $31.50.

As you can see, if you’re choosy, you’ll still find the biggest gains in the small-cap universe…no matter what.

Best,
Gunner
February 26, 2007

P.S.: You can read all about the fastest-moving penny stocks on the market in the new Penny Stock Fortunes. In fact, one of our picks is already up 25% as I type.

Greg Guenthner

Greg Guenthner heads up Agora Financial’s small-cap division and is the founder of one of the only independent OTC research advisories in the industry. A graduate of George Mason University, Guenthner joined Agora in 2005 after several years as a journalist. He is managing editor of Penny Stock Fortunes and Bulletin Board Elite.

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