Publisher’s Note:Today’s Sleuth is brought to you by the newest member of the Sleuth team – Greg “Gunner” Guenthner. Gunner is an eager 25-year-old journalist with a passion for investing. When I found out he was a fan of Wanger, Greenblatt, Templeton, Graham, Fisher, Buffett and T. Rowe Price, I convinced him to quit his job with a local newspaper (where he covered the political scene) and write for Sleuth.

In his inaugural letter, Gunner examines the bandwagon theory, explains why discipline is crucial as a small-cap investor and unveils five unheard-of companies you should put on your watch list immediately.

Enjoy.

James

Hello Sleuths,

It’s the time of year when almost everyone is promising (whether to themselves or to loved ones) to save more money, finish painting the guestroom or — if you play on the bandwagon — shed some pounds and get in shape.

I know I’m a little late to the party. By now, you’re thinking that some slightly less resolute novice has probably fallen off his new treadmill, never to climb on again. I just love the February classifieds. For sale: treadmill and weight bench, excellent condition, red bow still attached, make offer.

Hopefully, this won’t be me. No, I didn’t get a new treadmill for Christmas, but I did promise myself to be in better shape by this time next year. It’s not that I have a weight problem — quite the opposite, actually. My motivation comes from memories of high school and college, when I seemed to have the energy to play pickup games in the gym for hours and not even get tired.

As with most things in my life, I see some important lessons that can be learned from this about investing. First (and I think most important) is that when you make a resolution, keep it. Not necessarily because it’s the right thing to do, but because no one else seems to be doing it.

Think of your portfolio as if it were a gym membership. A lot of people are buying yearlong gym memberships this month. Some people spend hundreds of dollars on initiation fees, and then agree to a contract for 12 months. For arguments sake, let’s say the initiation fee for Trendy Gym is $350, and the monthly membership fee is $75. That’s $1,250 for a year at the gym! And you quit going after March? Are you serious?!?

But wait…Let’s check out the Get Real Gym. I know I want to get in shape this year, but I’m willing to wait until the summer, when most people are on vacation and too busy to hit the gym. Initiation fees are waived, because business is slow, and at my gym, the monthly membership fee is $30. That’s a steal at $360 a year. And when I resolve to go three times a week for a year, and keep that resolution, I have the added satisfaction of getting my  money’s worth and doing something good for myself well into 2007.

Investing Resolutions: Stay off the Radar

You see where I’m going with this? Let’s dupe the average investor by buying when he’s selling, and then selling to him when he and his bandwagon brothers are feverishly buying again. And let’s do this all while staying off Wall Street’s radar in our small-cap universe. More on this in a sec…

As for my fitness revolution…err, resolution, that is:

The best way to recapture my youthful stamina, I’ve rationalized, is to start running again. In high school, I was on the track team, running 5-10 miles a day, five days a week, almost year-round. Looking back, I’d say I was in the best shape of my life back then.

It is encouraging to read the old standby New Year’s stories in the papers. The Boston Herald writes that 12.4% of all new gym memberships are added in January, more than in any other month of the year. I mentioned this to some gym rats I know, and almost all of them complained. It seems that it’s impossible to get on the equipment for the first couple of months of the new year. But after the initial surge in interest, the gym returns to normal, they said, and the “regulars” can come back out of the woodwork.

Addictions are also the target of resolutions, as I’m sure you’ve seen. This one’s from Floridatoday.com: “Anti-smoking products tend to do well in January, said Lori Lukas, a spokeswoman for GlaxoSmithKline, Inc., maker of the popular over-the-counter anti-smoking aids Nicorette, NicoDerm and Commit.”

And of course, all of these articles are filled with the common man lamenting past New Year’s resolution transgressions, followed by the promise to stay between the lines this year.

But I think we all know what will happen. The news reporter does, too — which is probably why we don’t see many follow-up pieces in March or April about the success stories. Those making resolutions fell off track, treating the resolution as a fad instead of a true and permanent change in their lives…

Investing Resolutions: Bandwagon Theory

Which brings us to our second lesson, which pertains to Bandwagon Theory. I have derived this from Newton’s High School Popularity Maxim, which postulates that if you were to lock five or more teenagers in a room together, a complete social hierarchy would be developed in less than an hour, complete with geeks, preps and jocks.

The same is true in the stock market. The bandwagon theory states that investors travel in packs, these packs are emotional and these packs create a hierarchy of stocks — some that are popular and some that aren’t.

And those who drive the bandwagon will tell you it’s the only way to go. But since you’re reading this letter, I know you don’t believe them. Neither do I. Like the value-master Joel Greenblatt says, why spend all your time and energy picking random stocks that are popular this year only to find that when you do sweat out a profit, it usually is only about what you’d get if you bought T-bills?

The wagoneers also will tell you that you CAN’T find bargains among quality stocks. They’re cheap for a reason, they’ll say. Sure, there may be some great high-yield, small-cap stocks out there, but it’s just too risky to be worth the effort.

But you and I know that’s not true, either. If we took out a dartboard that had 100 random small-cap stocks listed on it and threw 20 darts at it, buying these lucky stocks, we probably would lose money. But if we took 100 stocks that met our specific criteria (like Greenblatt does) and threw our 20  darts again, the gains we could see would be limitless.

Investing Resolutions: Sleuth Resolutions

I know I’m going with the crowd as I attempt to get in shape in 2006, so I think we should make some solid Sleuth resolutions that go a little against the grain — and stick to them, no matter what our “friends” on the bandwagon have to say about it. If we make these promises to ourselves, we should be running like the wind for years to come.

Say them with me if you want:

First, I resolve to be steadfast in my investing, sticking to my guns when the numbers say so and selling when the reasons I purchased the stock in the first place are no longer true, regardless of what the crowd is doing. When I write my investing road map, and define my criteria, I will adhere to my rules this year and in years to come and reap my rewards. An investor with a plan is an investor to be reckoned with.

Second, I will make educated decisions about my investments. Value is not the monster under my bed. There are very real excellent deals out there in Pennyland to be had, and I will find them, no matter what the wagoneers are saying (see above resolution).

You can screen ‘em with the best of us, too. Just looking for high return on equity (a company’s return on shareholders’ money) and lower-than-industry average price-to-earnings ratios can churn up some promising small caps. These criteria show us A) how effectively the company spends shareholders’ money and B) how much we’re paying for a company’s earning power.

Just check out the ones listed below (all are less than $15):

Core Molding Technologies (CMT:AMEX)
China Energy Savings Technology (CESV:NASDAQ)
United Online (UNTD:NASDAQ)
Mesa Air Group (MESA:NASDAQ)
iMergent (IIG:AMEX)

So stay tuned this year. These are the kind of small-cap value picks you’ll find every week in the Sleuth. Also, be sure to stay tuned to Penny Stock Fortunes to build your own million-dollar portfolio just by investing in undervalued companies that spend money wisely.

Oh, I’ll keep running, too. And I’ll keep my ear to the ground and let you know what’s new out there.

Until then,

Gunner
January 2, 2006

Investing Resolutions: A Sleuth’s Resolution was originally featured in the Penny Sleuth.