*** As your devoted Penny Sleuth, it’s my life’s work to uncover the best small-cap data — those valuable nuggets that make the difference between a shrewd investment and a speculative gamble. One of my favorite (and least-known) indicators is aptly called Reuters’ Lesser Known Stocks screen, which has flattened the blue-chip S&P 500.

Rueters’ Lesser Known Stocks screen uses filters such as trading volume of at least 20,000 shares over the most recent 10 days, coverage by no more than five analysts, and institutional ownership of no more than 50% of the outstanding float.

But get this…of the screen’s 57 “noteworthy” stocks, 41 (71.9%) of them have a market cap of under $1 billion, qualifying them as small caps. According to its latest monthly update, Reuters’ Lesser Known Stocks screen outperformed the S&P 500 by a whopping 311.64% from Jan. 28, 2000, to Feb. 25, 2005.

Of the screen’s top three stocks, two of them are small caps. They are LaBarge, Inc., a maker of electronics systems that is trading at $12.45 (as of 10:28 a.m.), near the top of its 52-week range of $13.50; and Collegiate Pacific, Inc., a manufacturer and distributor of sporting goods. Collegiate Pacific is currently at $11.12 — down 25.95% from its 52-
week high of $15, yet up 34.8% from its 52-week low of $8.25.

Remember, the hottest small-cap companies are often the least known. So get out there and dig…

*** And in the spirit of research, you should go back and reread our story from Feb. 11 2005 called “Small-Cap Software Meets the Crusher” (http://www.pennysleuth.com/alertholder/02.11.05). Because today’s CNN/Money confirmed that small-cap software vendors are finding it harder and harder to compete against the big boys — but at the same time, their innovative products and customer base are proving increasingly valuable to the likes of IBM, Oracle and SAP.

The CNN/Money story indicated that we could be seeing the beginning of a “feeding frenzy” in small software providers — and this is great news for us. It means that companies that have languished with low P/Es, ROIs and ROAs may now realize their full potential as takeover targets.

While we advised against buying into small-cap software providers based on their fundamentals, those very same numbers are proving irresistible to industry behemoths looking to trounce competitors with low-hanging goodies. And as I mention below, this buying spree is also weeding out potential IPOs that have good products but mediocre numbers.

If you feel compelled to acquire shares in underperforming small-cap software companies, buy shares in so-called infrastructure companies — exactly the kind of opportunities we had identified. But only get into them if you think that they’re ripe for acquisition…otherwise, you’ll end up overpaying for a dud.

*** We’ve been telling you that the IPO market has been superheated — swelling the small-cap ranks with overhyped stinkers. Well, now that the first quarter of 2005 is nearly closed, the strain is expected to show.

Mid-March to mid-April could be sluggish. Skyrocketing oil prices, market instability and a glut of deals have dampened investors’ enthusiasm. Consequently, many IPO candidates are instead getting themselves acquired — making it easier for us to spot new small-cap stars in an overcrowded field.

According to Dealogic, there have been 44 IPOs so far this year, and their average percentage gain is 4.6%. While that’s better than a poke in the eye with a sharp stick, it’s underwhelming compared with last year’s first-month gain of 11.7% (for 36 IPOs) during the same period. The slip in 2005 supports a basic tenet of capitalism called supply and demand…and if you want to add the ideal of high quality for good measure, that would also be appropriate in explaining last year’s superior results.

Based on available data, we’re sticking to our guns. Let an IPO cool down at least 30 days, then watch it like a hawk before you spend a single penny. And if you sit out the rest of this year’s IPOs, that may not be so bad either.

*** Here’s the latest on Chris Mayer’s new CrisisPoint Trader service. Based on the classic Dow Theory, CrisisPoint Trader has been pulling in amazing profits.

In the meantime, watch your inboxes, because Chris is preparing a new report that will blow your mind…

*** Finally, Bruce Foerster of Aurora Capital shares his secret for determining how good a CEO really is (before you sink money into his company)…

Listen Up

I dare you to guess the biggest challenge for a CEO. Revenue growth? Strategic partnerships? Unwavering leadership? Not exactly. In fact, the answer is so simple that you’ll wonder why you’ve never heard it before…and how you can use it to find the best small-cap opportunities in the future.

Chances are the reason you never heard about it before is that you’ve never met Bruce Foerster, CFO of Aurora Capital. I found out about it by attending Foerster’s presentation for small-cap CEOs at the ValueRich Small-Cap Financial Expo, held March 9-12 in West Palm Beach, Fla. And if anyone should know the secret to being a great small-cap CEO, it’s definitely Foerster.

After nearly 30 years as an investment banker, Foerster has come upon the best and the worst of CEOs. He’s encountered their tantrums, arrogance and stubbornness. But at the same time, he has worked with wonderful CEOs who have managed to stuff the pockets of shareholders and executives with wads of money…and then have gone on to do it again and again.

Foerster’s insight into what makes a great CEO was also developed through his experience as a naval officer who spent 12 years at sea, as an expert witness for securities cases and as a lecturer at the Wharton School and the University of Miami. So when Forrester stood at the lectern in the conference room of the ValueRich expo, his insight about this secret CEO quality truly resonated.

Before he revealed his secret challenge, though, Foerster set the stage…

“Most CEOs are Type A and are used to getting what they want,” he said. “It’s up to the board to keep CEOs in line.”

That’s especially relevant with small companies, he observed, where “CEOs often don’t have formal training.”

So what is the biggest challenge facing a small-cap CEO? According to Foerster, it’s “listening.”

He cautioned investors that “The biggest risk is when a CEO stops listening to the board of directors, the market and other advisers.”

We agree. Here at Penny Sleuth, one reliable way for us to measure a CEO’s capacity to listen is through a company’s ROI.

A smart CEO who listens to customers will maximize shareholders’ investment by plowing it back into things that customers want. And the only way a CEO will know what a customer wants is by listening to them. Taking that into consideration, for us the benchmark ROI is 20% over two consecutive positive years.

Surprisingly, it’s not too difficult to find that kind of ROI in a small-cap company. Of the 6,703 small-cap companies, 2,873 (42.8%) boast a five-year average ROI of 20% or more — so that’s relatively easy to locate.

But drilling down, only 291 of those filtered companies showed a five-year average ROI of greater than 100%. Pulling out all the stops, three companies emerged as having the best quarterly ROI of the entire small-cap bunch. They were Northern European Oil Trust whose five-year ROI was 36,526.49% and quarterly ROI was 20,252.99%; Permian Basin Royalty Trust that posted a five year ROI of 1,210.47% and a quarterly ROI of 2,464.34%; and Tel Offshore Trust whose five-year ROI came in at 1,500.01% paired up with a quarterly ROI of 9,742.37%.

The three of them hold gas, oil and mineral rights in trust funds, and license those rights to the world’s biggest energy and mining companies through a trustee, which is often a bank. Hmmm…successfully negotiating rights with the toughest executives on the planet and scoring a quarterly ROI of 36,526.49%? That sure sounds like a pretty good listener to me.

Happy investing,

Irwin Greenstein

March 22, 2005

Listen Up was originally featured in the Penny Sleuth.