Irwin Greenstein reports from the home of “The Star-Spangled Banner”…

*** Since this is the last issue of the year, on behalf of the entire Penny Sleuth team, I wish everyone a happy, healthy and prosperous 2005. I’d also like to express my deep gratitude for your participation in making Penny Sleuth an enormous success since we started publishing it, on Oct. 12, 2004.

For those of us who championed the small-cap market this year, let me offer a New Year’s toast. I raise my glass of the bubbly Widow Clicquot for having the intelligence, guts and intuition to buck the know-it-alls, naysayers and scaredy cats by riding out tough second and third quarters…only to watch the Russell 2000 small-cap index rally in the fourth quarter by hitting an all-time high of 651.72 on Dec. 27. Wow!

*** That’s why I’m celebrating with an incredible opportunity. It’s an 80% discount on Carl Waynberg’s new GRIP service. This offer expires TOMORROW. So please take advantage of our great introductory price…because after Jan. 1, you’ll have to pay full price for this exclusive screening tool that tracks “jumper stocks” — the most explosive small-cap stocks in the world.

The GRIP identifies the tiny companies that trade on the forgotten OTC Bulletin Board and Pink Sheets exchanges, and eventually “jump” to the Nasdaq, AMEX or NYSE. And when they jump, investors can make a mountain of money.

Membership to The GRIP is extremely limited. So if you haven’t read your GRIP report yet, check your e-mail inbox now. Carl is the genuine article. He has made as much as 757% on a single pick by identifying the kinds of promising companies that are snubbed by the Wall Street establishment.

I’m urging you sign up BEFORE Jan. 1. That’s why I’m including a special link to this valuable information…

http://www.agora-inc.com/reports/GRP/WGRPEC16

With only one day left, don’t leave money on the table.

*** OK, now for the fireworks. James wraps up this issue by offering us his insightful and powerful outlook for 2005. His sage advice and common-sense predictions make it surprisingly simple to continue our winning streak into next year. In addition, he picks the hot small-cap companies to watch like a hawk…using the same criteria that have made investors profits of 86.7%, 172.7% and 94.4% during 2004.

Ring in the new year, James…

Our Small-Cap Predictions for 2005

It’s time to get out the crystal ball, look into the future and answer the question every small-cap investor has on his or her mind…

Will 2005 be a good year for small-cap stocks?

It will be for some, dear reader. But let me warn you, it will also be a terrible year for others. You see, right now is a critical time, a tipping point for the small-cap market. As it stands in this last week of 2004, small-cap stocks have enjoyed a five-year run — in which they have beaten the pants off of their large-cap counterparts.

Since 1999, the Russell 2000 has risen from 451 to 649. That’s a 43% total rise — or an annual compounded gain of 7.55%. Meanwhile, in that same time frame the S&P 500 (which houses the largest companies on Earth) has dropped from 1,387 to 1,211 — a pathetic minus 12.7% overall return and an annual compounded loss of 2.67%.

This past five-year stretch has been one of the most lucrative times ever for small-cap investors. In fact…

Dating back to 1932, there have only been five extended small-cap rallies like this one. So why on earth am I hesitant about predicting anything other than a raging bull market for 2005?

From a value perspective, small-cap stocks have almost caught up to their large-cap mates. And when that happens, investors will likely take money out of the small-cap market and invest in larger, less volatile companies. Check out the numbers for yourself…

The average small-cap company trading on the Russell 2000 is selling for 2.37 times book value and 20.88 times earnings. Meanwhile, the average large-cap on the S&P 500 trades for 3.01 times book and 21.4 times earnings.

One could argue that small-cap stocks are still slightly more attractive than their larger peers. On a price-to-book basis, they are trading for a 27% discount. And on a price-to-earnings basis, small caps are selling for a 2.5% discount. But let me remind you…

Historically, companies are considered overvalued above 1.5 times book and 17 times earnings. So by that measure, the average small-cap stock is NOT a bargain anymore. They just appear cheap compared to the ridiculously priced large-caps.

Folks, now is NOT the time to be chasing overpriced small-cap companies with no real earnings growth, no real sales growth and extremely high multiples. I predict 2005 will be a year of reckoning and heartache for investors who do.

2005 will be a year in which investors will do well to focus on basic, boring fundamentals. Those who invest in companies with top- and bottom-line growth, year over year and quarter over quarter, will walk away far better off that those who invest blindly in the “hot stock” of the day. And those investors who focus on earnings growth of 10%, 25% or more will outperform the rest of the market handily.

If you’re looking for some specific stocks that I expect could outperform in 2005, check these out…

I ran a scan of all the companies (trading on a major exchange) that were growing at least 10% quarter over quarter and year over year and trading for less than 1.5 times sales, 1.5 times book value and 17 times earnings. I figured these are the kinds of companies you want to own in 2005.

Guess how many companies (out of the almost 6,000 I had to choose from) fit the criteria?

FIVE! That’s it. Five lousy companies. And four of them were small-caps with a market cap of $1 billion or less.

In the spirit of making predictions, I’d bet these four small-cap companies will
outperform the market in 2005…

1) Jaclyn, Inc. (JLN:AMEX)
2) LJ Intl., Inc. (JADE:NASDAQ)
3) P&F Industries, Inc. (PFIN:NASDAQ)
4) Span-America Medical Systems (SPAN:NASDAQ)

(By the way, the one large-cap that came up was foreign-based Sinopec Shanghai Petrochemical Co. (SHI:NYSE) — a Chinese crude oil processor!)

We’ll see how these stocks perform over the next 12 months. But fundamentally, they are sound businesses. They are all growing and trading for very fair multiples. And I believe it will be these kinds of companies that will be good investments in 2005.

On to the next prediction…

Small-cap investors who are patient and buy stocks that the insiders are buying will outperform the rest of the market.

I preach it all the time, but it’s true. The people who run the businesses know better than anyone else when times will be good — and when stock prices should rise. I predict investors who follow the smart money in 2005 will come out ahead.

So what are the insiders buying now?

There are seven small-cap stocks worth keeping an eye on as we head into the new year. In each case, insiders have bought at least a million shares in the last six months — and the total insider buying outweighs insider selling tenfold or more. Here are the candidates to watch…

1) Alloy, Inc. (ALOY:NASDAQ)
2) Collins & Aikman Corp. (CKC:NYSE)
3) Concord Camera Corp. (LENSE:NASDAQ)
4) Incyte Corp. (INCY:NASDAQ)
5) Inhibitex, Inc. (INHX:NASDAQ)
6) Myogen, Inc. (MYOG:NASDAQ)
7) Valence Technology, Inc. (VLNC:NASDAQ)

Again, look for stocks with heavy insider buying to reign supreme as 2005 unfolds.

Finally, my last prediction…

Small-cap investors who are willing to look outside the United States have a chance to outperform everyone — including the highly paid Wall Street analysts. Each year, the top performing foreign market beats the U.S. market — hands down. For instance…

The best performing foreign markets from 1995-1998 were Switzerland, Spain, Portugal and Finland. Anyone who was wise enough to have invested in those markets could have walked away with gains of 45%, 41.3%, 43.9% and 122.6%. And they also would have beaten the U.S. markets by an average of 31.4% a year!

And in 2005, the same will be true.

Countries like India and Mexico could well lead the way. Heck, the small-cap market in India is already in full bull mode. I’ve reported in previous Sleuth alerts that Indian penny stocks have risen as much as 1,400% this year. I expect that trend will continue. I like India as a long-term investment for the next 10 years — which is exactly why I hopped on a plane and spent nine days in Mumbai this past June.

Who knows what opportunities will present themselves in 2005? I don’t have a crystal ball, dear reader. But I do know two things…

Those people who take their time and invest in solid companies (with strong
fundamentals and strong growth numbers) will outperform the majority of the rank-and-file investing public. And those investors who are willing to look outside the U.S. borders for opportunities will bring home the lion’s share of profits.

Keep an eye on Mexico and India.

We’ll see if any of my predictions come true. To find out, stay tuned to Penny Sleuth every Tuesday and Friday. Here’s to a fantastic 2005.

Cheers,

James Boric

December 31, 2004

Penny Sleuth Contributor

The Penny Sleuth also features commentary by other financial analysts, small-cap experts, investment gurus and an array of contributors from various fields and occupations. Their diverse insights and contrarian investing ideas are hand selected by the Penny Sleuth editors.

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