Curtis Jensen, manager of the Third Avenue Small-Cap Value Fund, was recently asked what his view of the market was. He responded by rolling his eyes and saying, “We don’t have a clue, nor do we care about the general market.”

Great fund managers never do care. They buy great businesses at great prices no matter what the market does. They know that over time, owning fundamentally sound and growing companies gives them the best chance to achieve above-average returns. And the key phrase in that last sentence is “over time.”

There are good reasons guys like Warren Buffett and John Templeton are billionaires several times over, and guys like Curtis Jensen, Marty Whitman and Ralph Wanger earn high returns for their shareholders year after year. They don’t lose sleep when the market dips. They don’t act like fools when the market rises. And they could care less what the Dow, Nasdaq, S&P 500 or Russell 2000 do in the short term.

And at Penny Stock Fortunes, we try to recommend small-cap companies that the all-time greats would be proud to own for years at a time. Take for instance, Borland Software Corp. (BORL:NASDAQ) — the leader in software delivery optimization — and VAALCO Energy, Inc. (EGY:AMEX).

At $5.26 a share, Borland is closer to its 52-week low than its 52-week high. In the short term, there’s no saying where Borland will trade. I offer no guesses. But with a market cap of $400 million, $190 million in cash and short-term investments, zero debt, an A-list of customers and an aggressive share repurchase plan, this is the kind of company that can double your money (or more) on the slightest hint of good news. Maybe that’s why Curtis Jensen recently added 1.5 million shares to his small-cap value fund.

Then there is VAALCO.

VAALCO, a $339 million company, has a nice little niche carved out in Gabon, Africa — where it produces 18,000 barrels of oil a day. Like Borland, it has a great-looking balance sheet with $49 million in cash and almost no long-term debt. But VAALCO also boasts growing top and bottom lines. Sales are up 50% in the last year and earnings are up 27%. And with net profit margins more than double the industry average and oil above $60, this tiny stock should still have room to grow — despite its 70% rise in the last three months.

As I mentioned in my original write-up of VAALCO, Columbia Wanger Asset Management is the largest institutional owner of EGY stock. It owns 4.35 million shares and doesn’t appear to be in any hurry to sell. That’s a good sign. Columbia is one of the 30 largest asset managers in the world. And it has strong ties to the great Ralph Wanger — one of my all-time favorite small-cap fund managers, who averaged 17% returns from the 1970s to the late 1990s.

Wanger made a fortune investing in out-of-favor, risky but sound small-cap companies. As he said himself, “You do best when your investments are controversial — when you stray farthest from the herd.”

No matter what happens to the broad markets, I will continue to feature in Penny Stock Fortunes solid small-cap companies that have a chance of rising — over time. At times, the picks will seem completely obvious. Other times, they will make readers uncomfortable.

Over time, my goals as the editor of PSF are that readers make money in the small-cap market, learn a lot about investing and take away at least one idea a month they can use in their own investment strategy.

And if you are an active trader looking for more than one idea a month, you might be interested in the brand new Small-Cap Insider — which will be unveiled to the public in the next month.

Peter Lynch, the successful Magellan Fund manager, famously declared, “There‘s no better tip-off to probable success of a stock than people in the company putting their own money in it.” And countless studies have shown: If you buy the same stocks the insiders buy, you will outperform the market.

Five of the most famous insider studies ever conducted were published between 1958–1976 by Rogoff, Glass, Devere, Jaffe and Zweig. They found that when two or more insiders bought a stock (using their own money) at roughly the same time, and the number of purchases far exceeded the number of sell transactions, the returns were (on average) two times greater than the market.

And even though these studies are old, they are certainly not out of date. Take another recent Penny recommendation, Safeguard Scientifics (SFE:NYSE), for example…

Safeguard is a “technology incubator” that has a stake in 12 different companies, ranging from technology, pharmaceuticals, software and others. In the November 2005 issue of Penny, we told you that company insiders loved this stock:

‑- The CEO bought 290,000 shares between $1.05-$1.35
‑- Four different vice presidents bought 95,459 shares between $1.05-$1.58
‑- And four directors bought 141,000 shares between $1.04-$1.41

In a very short period of time, SFE insiders spent over $550,000 accumulating their own stock. And during the three-month buying spree, there wasn’t a single sell transaction to note. Armed with that information, we recommended SFE at $1.41 a share. After just announcing great quarterly earnings, the stock now trades for $2.08 — up 47% in just a few months time. During the same time, the Russell 2000 is up only 12%.

But is this a fluke?

Not according to insider buying expert and author of Investment Intelligence from Insider Trading H. Nejat Seyhun. Seyhun studied insider buying and selling patterns ad nauseum between 1975-1994. After finishing his research, he concluded, “Data show that for those firms reporting insider buying activity, stock prices move up 24% during the subsequent 12 months following insiders’ purchases.”

I don’t care what the market does — if you can make 24% a year, you’ve done great work. In fact, I believe in this idea so much, I am in the midst of creating a product that is solely devoted to uncovering stocks with heavy insider buying… I’m sure you’ll hear more about it in the weeks to follow…

Happy Investing,

James
April 6, 2007

Byron King

Prior to joining Penny Sleuth, Byron received his Juris Doctor from the University of Pittsburgh School of Law, was a cum laude graduate of Harvard University, served on the staff of the Chief of Naval Operations and as a field historian with the Navy. Our resident energy and oil expert, Byron is the editor of Outstanding Investments and Energy and Scarcity Investor.

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