Success of Small-Cap Stocks

Jan 4th, 2007 | By Penny Sleuth Contributor | Category: Investing Strategies

The beginning of January is one of my favorite times of year. The market’s numbers are in the books and we can assess which stocks were the big winners and losers…and make mental notes of who was right and who was wrong.

And the results this year are fascinating.

First off, we’d be remiss if we didn’t make mention of the overall fantastic performance of the broader market. The Dow Industrials and the S&P 500 were both up about 16% for the year — an outstanding performance that is well above long-term averages for the two indexes. The tech-dominated NASDAQ lagged the two large-cap leaders, but still had a good year itself turning in 9.52%. Mid-cap stocks actually showed pretty well in 2006 with the S&P Midcap 400 climbing 10.32% by the end of trading last Friday.

The Russell 2000, however — the benchmark small-cap index — outpaced all of them.

For the year, the Russell posted a 2006 return of 18.37%, making it clearly yet another year to focus on smaller capitalization stocks.

But if we dig down even further, small-caps were the real giant slayers of U.S. Equity markets in 2006. Let’s look at the stats…

Of the top-50 best performing stocks of 2006, 46 of the 50 were small caps. That represents a staggering 92% of the ‘best of the best’ stocks for the year.

Of those 50, the average return was 382%. The highest return came from tiny Foamex International at 14,000%, while another in the top-five was one we had talked about in Small-Cap Strategy Report when it was about 500% below where it ended the year.

Interestingly, the SEC would actually classify 12 of the top-50 performers as penny stocks. These stocks are a subset of the small-cap universe that we will be focusing on much more in 2007 in our new relaunch of Penny Stock Fortunes.

But enough of these statistics. 2006 is over, and yet again we get more confirmation that small-cap investing is one of the best — if not the best — way for us to build wealth in the capital markets. Now is the time, if you haven’t done so already, to look forward to 2007 and beyond.

Ok…but what should you look at?

I’ve been pounding the table on three themes for the past couple of months in all of my publications and they are still the three most important areas for investment:

1. Home builders: They are despised by investors and yet many of the fundamental reasons they ran up in the first place are still intact. In true Buffett style, look at these stocks while most investors continue to turn their noses up at them. Yesterday, Lennar reported bad news for the sector — which is great for us. Buy some of the small-cap builders as long-term holds in your portfolio. Look for ones with the capital structure to ride out perhaps an unpredictably long clearance of existing home inventory.

2. Defense stocks: President Bush just reasserted his commitment to victory in Iraq and 20,000 additional troops could be sent into combat. Look at small-caps focused on equipment to protect troops — something on which Democrats will not fight the White House.

Some defense stocks (hovering around the small-cap range at present) to watch in this group:

3. Healthcare: This could be a protracted battle. In fact, Iraq and U.S. healthcare will likely be the hottest issues of the remainder of President Bush’s second term continuing into the next presidency. Democrats could pass legislation that attempts to make prescription drugs cheaper under Medicare. If the Democrats lose this fight, which we think is a real possibility, look for a rise in the whole pharmaceutical sector a la President Clinton’s failed healthcare reforms of 1994.

We’ll be making recommendations as, and hopefully before, all of these themes unfold.

Until next time,
Craig
January 4, 2007

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Penny Sleuth Contributor

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