In the current issue of Small-Cap Strategy Report, we wrote about the very encouraging results of this year’s Wall Street Journal’s “Best on the Street” for 2007 competition. It has direct implications for the stocks we all love best – small-caps.

The annual tournament of sorts is one of the purest competitions in the investment world. It ranks the analysts whose Buy ratings had the biggest gains and whose Sell ratings had the biggest blow-ups.

For 2006, The Journal looked at 45 industries and ranked the top five analysts in each, based on their skill of knowing when to buy a particular stock and when to sell it. It doesn’t get any purer than that.

Contestants were largely unrestricted when it came to which of their stocks would be eligible for honors. Just about any stock above $2 a share that traded on a major U.S. exchange was fair game.

Here’s how everyone was ranked — and it’s not as easy a process as you might think. First, every eligible research department’s rating scale was converted to the standard scale used by financial data company Thomson Financial. For instance, a Strong Buy rating was given a 1, a Buy a 2 and on down to a 5, a Strong Sell. Some firms have less than five-tier ratings scales, some have more. This must have been a nightmare…

The next step was to take all of those numbers and convert them to a 1-2-3 scale — Buy, Hold and Sell. On a five-point scale, the two most bullish ratings became Buys, the two most bearish became Sells and the middle one became a Hold. Basically, for each Buy-rated stock an analyst covered, the total return it accumulated while he had it rated a Buy gave him points. The analyst also got points for Sell-rated stocks that had negative total returns.

So what did we learn? For Small-Cap Strategy Report, we learned something very interesting…

The best-performing stocks of the top 10 all-stars this year were — you guessed it — small caps.

We at SCSR define stocks valued from $50 million-1.5 billion (sometimes to $2 billion) as small caps. Typically, we recommend stocks with values greater than $300 million or so, but on occasion, we will go lower to find a great value.

The all-stars in 2006 went low…very low…

When Thomson Financial tallied the results, eight of the 10 top-moving stocks were small-caps. STEC, the flash and DRAM maker, was the big winner, having climbed 236% during the time Pierre Maccagno at Needham had it rated a Buy last year. On the flip side, Rod Lache at Deutsche Bank called the drop in auto-parts supplier Dana perfectly, as it dropped 91% while he screamed Sell. Nice work.

And small-caps continue to do well as we speak.

As of May 31, the benchmark small-cap index, the Russell 2000, was up more than 8% year to date.

Something that we also monitor closely is the ratio of small-caps to larger-cap stocks amongst the top-50 best performing stocks year-to-date. Small-caps are dominating, as usual, by a ratio of 11.5 to 1. And some of those small-cap winners so far this year are posting massive returns, like Celsion (CLN: AMEX) up 270%, Transcend Services (TRCR: NASDAQ) up 435%, and Terra Nitrogen (TNH: NYSE) climbing 234%.

In the pages of Small-Cap Strategy Report and Small-Cap Insider, we’ll offer new ways to play our favorite slice of the market.

Until next time,
Craig
June 21, 2007

P.S.: We have few small-cap picks that we strongly feel can run with any of these “best of” winners.

Penny Sleuth Contributor

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