*** In a second, I’ll tell you how I got a bump on my head the size of an Easter egg and spent an hour with the local EMS crew last night. But first, I have a recommendation for you…

If you do not own a copy of Ralph Wanger’s book A Zebra in Lion Country, you must get one — today.

Wanger was the longtime fund manager and managing partner at Wanger Asset Management in Chicago. Between 1970 and 1996 (when the book was written), Wanger averaged a 17.2% return on his now legendary Acorn small-cap fund. To give you an idea just how amazing this is, consider this…

If you started with $10,000 and averaged only a 12% return over 26 years, you would be sitting on $190,400. And that’s if you never invested a dime more than the original $10,000. Not too shabby. But check this out…

If you put $10,000 in Wanger’s small-cap fund in 1970 and let it sit until 1996 — earning 17.2% a year — you would have been worth a cool $619,609. Think about that for a second…

A five-point difference in your annual return, over a long period of time, means the difference of making $190,000 versus $620,000. That’s the miracle of compounded interest, fellow Sleuthers. That’s why small-cap stocks have always, and will always, be a better investment vehicle for you over the long haul. And that’s why Wanger’s track record will go down as one of the best of all time.

So how did Wanger manage to make 17.2% a year for so long? He invested in small-cap value companies that would rise in one of four ways…

1.Organic growth: a company that continually grows earnings, dividends and book value

2.Acquisition: a company that is eventually acquired by a larger company — usually paying a premium to shareholders

3.Repurchase: if a company is trading below its fair value, it may decide to buy back its shares — recognizing the true value in itself

4.Revaluation: once a small company gains institutional interest, it will grow rapidly — causing valuations and the stock price to soar.

Wanger goes on to say, “Good-quality smaller companies can produce stock market profits by any of these four mechanisms. The best hope for established, big-company favorites is the first — only one out of four.”

Basically, the crux of Wanger’s book is this…

Small-cap stocks are volatile creatures. When they fall, they fall hard. And most people can’t accept that. They can’t accept underperforming their peers (or the market in general). To avoid that ever happening, the average investor simply invests in the same stocks his peers do — the IBMs, P&Gs and GEs of the world. That way, they can never really lose — psychologically speaking.

Wusses!

As a small-cap investor, you are investing outside Wall Street’s comfort zone. If you were a zebra in the wild, you would be on the outskirts of the herd…

You would be one of the few zebras who opt to eat the green grass that hasn’t been trampled on by 1,000 other zebras. Of course, the risk you take is that a lion sees you…

It’s a real risk. But in the end, you have to determine your own tolerance for risk. Do you want to invest in the IBMs of the world — and seek the same returns as everyone else? Or do you have the guts to go against the herd and invest in small-cap stocks?

I doubt you would be reading this is you were an IBM investor…

*** By the way, I had to buy A Zebra in Lion Country through Amazon.com, because it’s out of print. I think I paid $7.98 for the book — shipping included! So it wasn’t too bad. I would strongly suggest reading it. You WILL be a better small-cap investor when you are finished.

*** Speaking of herds, I was playing basketball last night at Indiana University’s main gym. I was feeling good — kicking the crap out of the 18- and 19-year-olds. But then it happened…

My teammate put up a shot. It rimmed out and came down on the opposite side of the basket…

My eyes lit up and I jumped for the rebound — with nine other guys around me…all within about five feet. As I went for the ball, I collided with a player on the other team. I felt an intense pain on the top of my head. And then one guy yelled, “Holy s^&*, he’s bleeding like crazy!”

Turns out, the guy cut me with his front teeth — on my way up to get the rebound. The ambulance arrived to treat me. After getting some glucose back into my system, I felt fine. I just have a knot the size of an Easter egg. And I had to sleep with gauze strapped to my head. But it’s fine now…

(By the way, I did end up getting the rebound…and I put it back in for an easy bucket! But that’s a moot point now.)

*** All last week we told you how great Chris Mayer’s new CrisisPoint Trader is doing. Using his system he is able to make small-cap type gains in a few weeks — even days. Well, he hasn’t let us down. He booked 31% profits in 14 days on Whirlpool calls. Then, he just closed out 41% profits in Wynn Resorts puts in two days! His other two positions are currently profitable.

*** We all know about the big American holiday in July. But according to Irwin, there’s another date in July that will give small-cap investors a reason to celebrate. Party on, Irwin…

Eyeballing July 15

One reason Wall Street money managers pocket so much money is that they can state the obvious with enormous conviction. After all, if the so-called experts agree with each other, and they all do the same thing, then it becomes a self-fulfilling prophecy. But we think that come this summer, a bunch of money managers will instead be dead wrong — and we have history on our side to prove it.

The Wall Street pack registered its collective voice in a quarterly survey dated March 2005 conducted by the Russell Investment Group (the folks who brought us the small-cap Russell 2000 Index). Of the nearly 100 buttoned-down prognosticators, 71% were bullish on large-cap growth stocks. Only 32% were bullish on small-cap growth. And small-cap value stocks ranked the least favorite of our consensus-happy experts, garnering a bullish rating of merely 29% (compared to 45% who favored large-cap value).

What’s the point of the survey?

On Wall Street, the process of surveying the professionals is called “sentiment,” and it’s typically used to build forecasting models based on the opinions of people who, as it turns out, generally think alike. After all, with all that responsibility resting on their shoulders, imagine how much easier their jobs are when they can point to a million other money managers who all made the same mistake.

This time, they have turned their sentiment against small caps. Actually, since early last year, Wall Street has been warning us that large caps are about to overtake small caps — after an incredible small-cap joy ride…

For the past five years, the small-cap Russell 2000 index returned a profit of 4.3%, versus a loss of 2.73% for the large-cap Russell 1000. Over the past three years, the Russell 2000 generated a profit of 8.03%, while the Russell 1000 coughed up a paltry 3.35%. But over the past year, the tables turned hard, with the Russell 1000 returning 7.24%, compared with the Russell 2000′s 5.54% — the contrast becoming notably stark in the year-to-date returns, a 1.90% loss for the Russell 1000 against the Russell 2000′s bloodbath of minus 5.37%.

But come July 15, we think that the past and the future will collide to decimate popular sentiment…igniting an afterburner of small-cap enthusiasm. That’s because the onerous Sarbanes-Oxley Act will take effect that day for many small-cap companies.

Sarbanes-Oxley was enacted in July 2002 as a post-Enron legislative cure for executive fraud. The new law beefed up requirements for record retention, financial controls and a higher level of accountability for CEOs, CFOs and directors. Sarbanes-Oxley is very expensive to implement, and small-cap companies are eating the expense big time —
resulting in missed earnings, lowered earnings and reduced profits. Relatively speaking, the cost of compliance is much higher for small caps than for large caps, hence the longer grace period.

For example…

The law firm of Foley & Lardner said that under Sarbanes-Oxley, the average cost of being public for a company with annual revenues under $1 billion (think small cap) will surge 130%, or $1.6 million. That covers everything from accounting and audit fees, computer systems, liability insurance and higher director compensation to offset the
increased personal financial risk.

The fallout is already impacting small-cap companies and souring investor sentiment. In the CSX Alert from March 30, Angela Roberts wrote that Harvard Bioscience turned in depressed results. Even though the company’s 2004 revenues were up 6% over 2003, net income was down $2 million due to Sarbanes-Oxley compliance. And when another
small-cap company, OCA, Inc., delayed reporting its 2004 results as it struggled to implement Sarbanes-Oxley, the company’s stock plunged 10%.

While the Wall Street wingtip crowd gives small-cap CEOs a punishing knee to the groin, we wonder if they see the long-term benefits for small-cap investors that arise from Sarbanes-Oxley…such as unprecedented transparency, stronger corporate governance and stricter reporting by foreign-based small-cap operations. Because while the analysts focus on quarter-to-quarter growth, we’re expecting a small-cap renaissance after July 15.

In part, that’s because we believe that small-cap investing will never be safer. All you have to do is look back to the Securities Act of 1933, which ensured the reliable disclosure of pertinent information relating to publicly offered securities. The following year, the Securities Exchange Act of 1934 focused on secondary markets, ensuring that the parties that trade securities — exchanges, brokers and dealers — act in the best interests of investors. The Securities Exchange Act established the Securities and Exchange Commission as the primary regulator of U.S. securities markets. In this role, the SEC gained regulatory authority over securities firms — eventually hunting down the likes of Michael Milken, Bernie Ebbers and Kenneth Lay.

And small-cap stocks boomed…

Large caps registered gains of 46.5% in 1933…but small caps more than doubled, rising 104.2%. Small-cap stocks jumped 41.5% in 1935 and then gained another vigorous 36.4% the year after. So can history repeat itself with similar run-ups after the important small-cap compliance deadline of July 15?

As of that date, a portion of the 2,959 small-cap companies with valuations between $75 million and $1 billion must meet the Sarbanes-Oxley compliance deadline. It applies to companies that we categorize as small-caps that have not yet met the initial compliance deadline of Nov.15, 2004, due to the SEC’s revised schedule, based on corporate fiscal calendars, annual-report distribution and other criteria. That’s why we think July 15 is a significant milestone for investors looking for reliable, small-cap opportunities.

So let Wall Street turn bearish on small caps and leave the winners to us. Our sentiment forecasts a busy (and lucrative) summer.

Happy investing,

Irwin Greenstein

April 1, 2005

P.S. In mid-April, Angela Roberts will publish an in-depth report on the impact of Sarbanes-Oxley on small caps. Stay tuned at www.psfortunes.com.

Eyeballing July 15 was originally featured in the Penny Sleuth.

*** In our last Penny Sleuth, Angela Roberts told you
about the most profitable way to a girl’s heart — diamonds. Shortly after
Angela’s story hit your inbox, (http://www.pennysleuth.com/alertholder/03.25.05), I got a call from Carl (The GRIPPER) Waynberg who said that he
had a little-known, north-of-the-border angle on the diamond industry that would
even give Hell’s Angels the shizzle.

So rather than start with our customary news briefs,
outlooks and colloquium, I’m turning it over to Carl…

*** My colleague Angela Roberts deserves a thank you for
at long last putting that eternal question to bed. Yes, yes, yes…a thousand
times yes, a resounding, if not emasculating and shriveling yes: SIZE DOES
MATTER.

When it comes to diamonds, that is. (Whew!)

When it comes to the industry built around the coolest
kind of ice, well you might say it’s not just the size of the ship, but the
motion of the ocean. Underneath their eye appeal, diamonds have a nasty (read:
bloody) reputation. To the rescue: Canada.

“Canada? You’ve gotta be kidding!” As former Hope Diamond
owner Elizabeth Taylor once purred while shilling for White Diamonds perfume,
“Not so fast.”

True, it wasn’t so long ago — 1990, in fact — that there
was no such thing as a Canadian diamond industry. But a year later, all that
changed.  The discovery of diamonds in Canada’s rather brisk Northwest
Territories in 1991 was an early indication of a nascent transformation in
Canadian mining and the world diamond-mining scene.

Lac de Gras was the site of the initial discovery of
diamonds in Canada. The Lac de Gras find would become the Ekati mine, which is
operated by Dia Met Minerals and BHP Billiton. Three years later, a second
discovery was made at Diavik, now operated by Aber Diamond Corp. and Rio Tinto.

Those inclined to punning might say Canadian diamond
exploration is still an industry in the rough. After all, it’s entering only its
seventh year as a diamond player of any weight. But already it’s the world’s No.
3 diamond producer, behind Botswana and Russia. In 2002, Canadian mines produced
approximately five million carats. In 2003, Canadian
diamond production more than doubled to 11.2 million carats. In a
very short time, Canada has gone from a non-entity in the diamond biz to a
supplier of about 15% of the world’s rough diamonds. Today, nearly half of all
funding for diamond exploration goes to Canada.

Even more impressive than the huge growth itself is the
fact that the huge growth has come on the strength of just two active diamond
mines: Ekati and Diavik. Snap Lake, a joint venture between De Beers and
Winspear, is slated for full production in 2007. When it becomes active, it will
propel Canada passed Russia into the No. 2 spot — with just four

active mines.

As for the size-of-the-ship/motion-of-the-ocean
metaphor…Canada’s diamonds proudly stand up to competition in terms of size —
and they offer one crucial advantage over the competition: Unlike diamonds from
Angola, Liberia, and Sierra Leone, for instance — “blood diamonds” used by
evil-doers to finance political conflict — Canadian diamonds
are “clean.” Consumers’ preference for clean diamonds is one of the
reasons one major diamond retailer cut a deal with a junior miner to buy or
market all the diamonds a future Canadian mine produces.

Canadian law enforcement agencies are working hard to keep
the country’s diamonds clean. As it turns out, it’s not just consumers who
prefer their bling-bling blood-and-guts-free; four out of five and Hells Angels
agree: Canadian diamonds are the shizzle.

The robust growth of the country’s diamond industry, from
nobody to world’s third largest by value in a little more than a decade, has had
the anticipated moth-to-a-flame effect, attracting the attention of such
luminaries as the Hells Angels and Eastern European crime gangs.

The mining segment of the industry is, the thinking goes,
less vulnerable to infiltration by organized crime — at least for the time
being. Evidently, the leather-heavy heavies prefer balmier temps to the
sub-arctic conditions of the Northwest Territories, where most mining activity
is currently focused. But if they ever discover GORE-TEX, the Mounties will need
to be extra vigilant.

Post-mining industry segments, however, like cutting and
polishing, are more likely to attract unwanted attention, because Canada’s work
pool in these trades is already stretched thin. It’s also more likely that it
will be Eastern European crime groups who come a-courting, since they’re already
involved in various facets of the diamond industry
in other parts of the world. The Criminal Intelligence Service of
Canada, which in the past has warned about potential infiltration by Eastern
European street toughs, is also becoming increasingly concerned about outlaw
biker gangs. When organized (or disorganized) crime wants in on the action, you
know you’re on to something.

Ms. Roberts suggested some ways to play the diamond
industry. I’ll suggest one, to junior explorers. One point in particular is
worth noting: Dia Met, Aber and Winspear are all junior miners that have
partnered with seniors as a way to mitigate risk and transform themselves into
industry leaders. That’s the same trend that was evident among junior

gold explorers.

(Warning: Shameless Plug Ahead!)

A number of junior Canadian diamond explorers hope to make
that same transformation. Some of the names I’ll reveal to GRIPPERS in a few
weeks are already proving themselves important players on the relatively young
Canadian diamond scene.

(How’s that for dangling the carat?)

*** Thanks, Carl. If you folks would like to find out more
about The Grip’s winning microcap picks, visit www.the-gripper.com.

Next up, we discover a Silicon Valley innovator that’s
transforming the global cell phone market…

The Echo Killer

The year was 1985. Dr. Irwin Jacobs and Klein Gilhousen
were driving back to their office in San Diego from Los Angeles. They had just
come from an intriguing meeting with ace defense contractor Hughes Electronics.
The topic of discussion? The next big thing in satellite
communications.

Jacobs was an electronics genius and MIT alumnus. He had
already made millions from the sale of his first computer company. Gilhousen was
a crack inventor, with several key patents to his credit. Their startup,
QUALCOMM, had been retained by Hughes to tackle vital theoretical problems of
perfecting communication satellites for phone calls.

Cruising southbound on I-95, both men struggled with a
thorny question: How do you make satellite phones more efficient without
spending a fortune?

Jacobs and Gilhousen reached an ingenious realization.
During a wireless phone call, considerable network capacity is wasted by the
pauses that naturally occur. That capacity vanishes…taking profits with it.

So Jacobs and Gilhousen wondered if you could fill those
pauses with bits and pieces of other conversations. In effect, what they
proposed was the equivalent of rapid lane changes for a conversation — without
any loss of call quality.

If they could pull that off, wireless networks could
become three times more efficient…and Jacobs and Gilhousen could pocket millions
of dollars.

They went on to develop the technology that would digitize
a wireless voice conversation so that it could be taken apart and put back
together. The typical zeroes and ones of a digital format would be precisely
assigned to the pauses on neighboring channels and then meticulously reassembled
at both ends of the conversation. And the people talking
would never know it.

When their breakthrough evolved from satellite systems to
cell phone networks, Jacobs and Gilhousen hit pay dirt.

Today, about 70 million cellular subscribers rely on
QUALCOMM’s breakthrough. In return, shareholders have been rewarded quite
handsomely. Since its IPO in 1991, QUALCOMM’s market cap has hit $59.8 billion. 
Not too shabby.

While it’s obviously too late for any small-cap investor
to get in on the ground floor of QUALCOMM, there’s another California company
458.1 miles due north — right in the heart of Silicon Valley — that’s toiling
away on the next big thing in cell phones.

The company is called Ditech Communications Corp., and its
innovation could make this small-cap whiz the next QUALCOMM based on this
equation: What QUALCOMM originally did for wireless-network efficiency, Ditech
does today for cellular call quality.

In a nutshell, Ditech develops systems that eliminate
annoying echoes in cell phone conversations. While Ditech’s team in Mountain
View is home to a bunch of brilliant propellerheads who design the hardware and
software, the chief financial officers of the biggest cell phone providers are
extremely interested in its products.

That’s because when it comes to the viciously competitive
cell phone market, service providers such as Sprint, Nextel, Verizon, Cingular
and AT&T understand the equation between high call quality and low customer
churn.

In fact, it’s because the carriers have been buying
products from so many different companies that they have the call-echo problem
to begin with.

The problem is that computers used in cellular networks
adhere to international standards that allow them to work together. These
computer standards are extremely hairy cousins to the universal engineering
specifications that let you plug in a toaster, change a light bulb and move your
telephone.

Despite the best intentions of the computer makers and the
engineers who designed the standards, achieving compatibility between the
systems is an extreme sport — not for the faint of heart. The computers that
route your call, let you roam and keep track of your minutes come from different
manufacturers, each with varying degrees of loyalty to the standards. So what
you have on your hands is a classic summer family reunion: Everyone is related,
but they really can’t stand each other. A side effect of this insanity is the
cell phone echo that sounds like you have water in your ears.

Ditech’s products are akin to a computer-systems mediator.
Ditech’s systems plug directly into the network and help eliminate the
interference and static that arises from incompatibility issues. The result?
Goodbye, echo.

Silicon Valley insiders would call this breakthrough a
“disruptive technology.” It means that the obvious and foreseeable path of
development is suddenly disrupted by a surprise innovation.

QUALCOMM did it by dramatically improving the number of
calls that could be squeezed onto a cell phone channel, helping drive down the
economics so that anyone could afford to make a call.

The power of Ditech’s echo-cancellation software won the
attention of semiconductor giant Texas Instruments — and gave Ditech
significant heft. In April 2002, Ditech sold its echo-cancellation software unit
to Texas Instruments for $26.8 million. The deal was a stroke of
genius.

First, Ditech got a boatload of money that it could plow
back into the business. Second, Texas Instruments is licensing the software back
to Ditech — entitling Ditech to all of the upgrades by the chip maker. This
makes a lot of sense if you compare the R&D budgets of Texas Instruments
(whose revenues are $12.5 billion) and Ditech (with 2004 revenues of $69.6
million). Third, Ditech can continue selling the software independently or
through joint marketing and sales arrangements with Texas Instruments — the
biggest chip supplier to the cell phone industry.

Regardless of how Ditech gets through the door of cellular
service providers, the benefits of the echo-cancellation software to them are
abundantly clear.

Ditech’s echo-cancellation solutions encourage people to
use their cell phones more frequently. This is a very big deal, because it
drives up call minutes and improves customer satisfaction. For cell phone
carriers, the cost of signing up new customers is on a steep rise. Nextel is a
prime example…

During the first quarter of 2004 alone, Nextel spent 31%
of its operating revenue, or $971 million, on getting new customers — that’s a
23.5% increase over the same period the year before, when the company spent $786
million. Those expenses include sales, marketing and retail operations. As a
separate line item, Nextel also sells its phones at below cost. The subsidy is a
carrot to attract more customers — a practice that the company may increase.

It’s easy to see why Nextel, along with its competitors,
will do almost anything to keep its customers happy. And one of the best ways to
keep customers is to provide awesome service, which is a tricky proposition
considering the tidal wave of new cell phone users coming onto the networks that
drive constant upgrades.

Research firm International Data Corp. expects the number
of wireless subscribers worldwide to hit 1.5 billion by the end of 2004. You can
bet that each one of those 1.5 billion customers will drop their service
provider like a hot potato if their call quality stinks.

Based on its experience, Ditech has several new products
optimized for broadband. The company continues to enhance its solutions for
satellite communication as well — the same market that gave QUALCOMM its start.
And Ditech is concentrating heavily on Voice over Internet, or VoIP, as it’s
called.

VoIP is red hot. It’s nearly impossible to open a business
magazine without reading about VoIP. It was a front-burner issue for former FCC
Chairman Michael Powell, who wants to make the technology widely available to
drive down phone-call costs to that of e-mail. That’s CHEAP. Especially for
international calls.

But one of the biggest stumbling blocks to VoIP has been
call quality. Not only can the calls suffer from echoes, but also from a lag
between the callers — those surprise dead spots. The carriers, meanwhile, are
eager to adopt VoIP because it will save them billions of dollars in upgrading
and maintaining the archaic telephone network already in place.

Looking ahead to the rapid evolution of cellular and VoIP,
Ditech is ideally positioned to cash in. And given that the stock is hovering
near its 52-week low, this may be the time to strike.

Here’s why…

On March 23, Standard & Poors announced the addition
of Ditech to its S&P 600 SmallCap Index. In reviewing the criteria for index
additions, S&P looks for companies that have a “reasonable per-share price”
and “financial viability, usually measured as four consecutive quarters of
positive earnings.”

In Q3 2004, the company reported revenues of $21.3
million, which gradually climbed that year to peak in Q1 2005 at $25.5 million
in Q1 2005…only to dip back to $21.3 million in Q3 2005. Likewise, EPS during
the period started at 20 cents, getting as high as 29 cents in Q2 2005…only to
settle back down to 21 cents in Q3 2005.

But get this: During that year-over-year period, gross
margins soared from 66% to 78%.So why did the company’s stock tank from a
52-week high of $26.87 to $12.74 as of 10:35 this morning?

The answer is found in a press release from Nov. 3, 2004,
when Ditech reported preliminary Q2 2005 results. That’s when management broke
the bad news: The company could not fulfill a $5 million order to two new Asian
customers, impacting second- and third-quarter sales. Suddenly, Ditech fell off
a cliff…

On Nov. 3, Ditech closed at $22.29. On Nov. 4, it opened
at $15.00. Overnight, the company shed 32.7% of its value in an avalanche of
trading…and except for a spike the stock has been in a steady
decline.

Does that make Ditech a value play? It’s very possible.
The company continues to develop groundbreaking products for a world class
customer base. By diversifying into VoIP, Ditech is selling into a $6 billion
market, according to Infonetics Research. And in December last year, the company
embarked on $35 million stock buyback program —
telling Wall Street that it has a bright future. Or does it?

Because since Nov. 4, 2004, Tim Montgomery, Ditech’s
chairman, president and CEO, has dumped at least 300,000 shares in a series of
planned sales and exercised options.

Yet on March 20, 2005, Barron’s reported that Ditech
shares were poised to rally, citing a a recommendation from small-cap brokerage
B. Riley, based on projected revenues and its VoIP product line.

The next quarter could be the turning point for Ditech. If
management can convince Wall Street that it has its supply kinks worked out,
that sales and margins will continue to rise and that the buyback program
solidifies the stock, it’s possible that Ditech could regain its momentum and
become the next QUALCOMM.

Happy investing,

Irwin Greenstein

March 29, 2005

The Echo Killer was originally featured in the Penny Sleuth.

*** 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.

Well, folks, this week we have a special issue of Penny Sleuth. Our very own Penny Sleuth, Irwin Greenstein, and resident OTC expert, Carl “the Gripper” Waynberg, have been debating whether nanotech is the next powerhouse technology or dot-com blow-up.

In fact, they have been publicly arguing on the topic for well over a week now. And it’s gotten UGLY. In fact, we jokingly said at our editors-only conference last week that a referee was needed so this little riff didn’t get violent.

We may be too late. Word is that Irwin and the Gripper have already exchanged punches. However, no blood was shed. I think they both missed each other. That could change today though — in our first Penny Sleuth Smack Down.

Both our contestants will plead their cases for and against nanotechnology. They will exchange investment blow after blow — until someone can’t stand it a second longer. And in the end, you will have to decide who is right — Irwin or Carl. (Or maybe they both full of crap! You let me know.)

Remember, Carl thinks nanotech is a gold mine. Irwin thinks it’s a sink hole. So here we go…

In the tradition of Ali v. Frazier, Alien v. Predator, and Kerrigan v. Harding, I present The Penny Sleuth v. The Gripper:  Nano No-Go or Nano Mojo? You decide…

Gents, LET’S GET READDDYYYY TO GRUMMMMBBBLLLLEEEE…

P.S.

If you want to find out more about Carl’s incredible track record using his Grip trading system, check out his Web site at www.the-gripper.com.

Nano Smack-Down: The Penny Sleuth v. The Gripper

CW: Irwin, you ignorant slut. First of all, does it not strike you as even a little ironic that the editor of Penny Sleuth — an investment service built on the lionization of the smallest participants in the stock universe — is condemning the physical universe’s smallest participants? Do you not recognize the irony in that? But you’ll be happy to know, Irwin, that thanks to nanotech, you can now get a lot more irony into a much thinner space.

IG: Then let me do just that. Let me set you and the record straight from the get-go about the nanotech sector that you think is so hot, hot, hot. The best news about nanotech is that if you Google the word, you’ll get 161,597.2% more results than if you searched for “Virgin Mary cheese sandwich” — that petrified, toasted artifact with a supposed likeness of the Blessed Mother’s face that recently sold to an Internet casino for $28,000.

CW: When did I say the nanotech sector is “hot, hot, hot”? In fact, I don’t think it’s hot, hot, hot, which is exactly why I’m big on it now. If it were hot, I’d be waiting for it to cool off.

IG: Hot or cold, simply put, nanotech is the Virgin Mary cheese sandwich of Wall Street. It’s sort of something, but not really, depending on how drunk you are and if the light is just right. I know that with a true believer like yourself, anything is possible. But for the devoted and humble Penny Sleuth, anything is NOT possible.

CW: Another irony. I’m talking hard science; you’re making quasi-religious allusions, though you’re right when you allude to the religious-like fervor nanotech went through, a fervor that accompanies any new technology’s intro to the Street. But in fact, nanotech’s not a new technology at all. You remind me of that Woody Allen line: “My Lord, My Lord, what hast Thou done, lately?” We all know the working definition of nanotechnology: the manipulation of physical matter on a molecular level.

But nanotech can really be thought of as another utilitarian application of quantum physics. Understanding how things work on a subatomic level — the interplay of forces and particles, etc. — has changed everything about our lives. Computers, the Internet, microwave ovens and on and on and on — none of these things would exist without an understanding of quantum mechanics. The term “nanotechnology” has been in use since the mid-’80s, and the underlying concepts have been around for 40 years, ever since theoretical physicist and noted madcap Richard Feynman dared to ask, “What would happen if we could arrange the atoms one by one the way we want them?” Well, we’re now at the molecular stage. It won’t be long before it’ll be atom-by-atom manipulation. You’re reacting today just like Feynman’s listeners reacted more than 40 years ago to his lecture “There’s Plenty of Room at the Bottom.”

IG: I know there’s plenty of room at the bottom. All you have to do is look at the Merrill Lynch Nanotech Index, which, in the interest of irony, was launched on April Fools’ Day 2004. Of the 25 equally weighted companies in the index, only five reported profits in their most recent earnings announcements. Reading through them, the phrase “net loss” became mind numbing. I got so depressed thinking about those poor investors that I had to satisfy my craving for something substantial with a bacon cheeseburger from the Mount Vernon Stable.

CW: Merrill Lynch’s introduction of its nanotechnology index was an unabashed, insulting attempt to cash in on the nano craze. When it introduced the index — I think April Fools’ Day was appropriate — most of the 25 names on the index had nothing to do with nanotech by its real definition. But it strikes me as paradoxical, Irwin, that in one breath you criticize the Street for hyping an unworthy technology, and in the next you invoke the Street to support what you’re saying. It’s been proven time and time again that you can hardly do better than to do the opposite of what Wall Street’s delicate geniuses are telling you to do. And there’s also proof, by the way, that the time to buy stocks is not when earnings rise, but when they fall — when they’re taken down, not bid up. I’m much more comfortable with nanotech as an investment now than I was a year ago, now that there’s been a bit of a shakeout. The National Science Foundation predicts that nanotech will be a $1 trillion market in 10 years. The federal funding for nanotech research increased 728% between 1997 and 2004. Both Clinton and George W. have increased nanotechnology funding. George W.’s 2005 budget — even with cutbacks in other areas – increases nanotech funding to $982 million. When a technology comes along that bridges political ideologies and science, it’s time to take notice.

IG: If you want to throw numbers around, Carl, try these out: Since 1998, the venture community has invested only $1.2 billion in nanotech startups. If that sounds impressive, let me put it into perspective. In 2004, VCs invested a total of $20 billion in new companies, and of that largess, nanotechs got a paltry $200 million. And that’s down from $385 million two years ago.

CW: Music to my ears. VCs are being a lot more prudent. They’re still feeling the dot-com burn, and that’s a good thing. They’re looking for late-stage companies, companies with proprietary technology that will be the basis of commercialization or, ideally, companies already generating revenue or that are on the cusp of it. Really, they’re looking for GRIP picks, but it would be self-serving to say that, so let’s take a look at what non-GRIP companies are doing about nanotech: Dow, DuPont, Exxon Mobil, ChevronTexaco, Motorola, Boeing, Hewlett-Packard, IBM, Intel and a growing number of Fortune 100 companies are devoting more and more of their R&D efforts to nanotech.

IG: Carl, you should pull your head out of the lab beaker. OK, so the lab-coat set is busy rearranging molecules for products that may or may not be safe for consumers. Because from where I sit, when we talk nanotech, we’re talking about screwing around with the natural order of things at the most basic level. In Thailand, thanks to the glories of nanotech, they’re producing rice that’s green and purple. Our very own USDA is force-feeding nanotech antibiotics to chickens. And BASF, Kraft and other big companies with billion-dollar labs are developing new nanomaterials to extend the shelf life of their food. I’m telling you, Carl, once the mass media get ahold of this news, there’ll be riots in the streets, like the massive frankenfood protests in Europe. R&D is worthless if there’s no market for the end products — or, worse, if people are afraid of them.

CW: “The natural order”? So I guess you don’t go to a doctor. The natural order is what we decide it is. You’re right, though, Irwin, there are some potential hazards associated with nanotech. The good news, from an investment standpoint, is that there’s no one to blame. Who does one hold accountable for the basic nature of nanotech materials — God, maybe, but I’d say he’s safe from litigation. This isn’t asbestos…there’s no one to point a finger at.

But it’s not like nanotech is this insidious, festering virus. In fact, one nanotech company — EnviroSystems — developed this product it calls EcoTru. It’s a nontoxic, noncorrosive, nonirritating, hospital- and military-grade disinfectant that has proven 100% effective in killing E. coli, TB, staph and a bevy of other viruses and bacteria. Best of all, it kills these little buggers without doing us any harm, which is why it’s the only disinfectant on the market that carries no warning labels. Have you heard of Angel Docs? It is a group of doctors who do pro bono work in Third World countries. They were doing work in Africa, ran out of surgical disinfectant and had no choice but to give EcoTru a try. It hasn’t been approved for this purpose, and EnviroSystems had no idea that the docs used it this way until after the fact. EcoTru proved 100% effective in eliminating post-op infections in 500 out of 500 cases. So much for harmful.

But the salient question here is can investors make money in nanotech? And clearly, the answer is yes. Do you know that $20 billion of Intel’s revenue is derived from nanotech? Twenty billion dollars! And we’re just getting warmed up.

IG: Not if Bill Joy has something to do with it. As the co-founder of Sun Microsystems, Joy is one of America’s foremost scientists. In the April 2000 issue of Wired magazine, Joy’s landmark article, which called for a moratorium on nanotech, galvanized environmental groups and nanotech skeptics who agreed with him that the risks of reshuffling our subatomic world far outweigh the hyped-up benefits. Let me see, do I want to line up behind Bill Joy…or some Fortune 500 CEO who could be next in line to take the perp walk?

CW: You mean Kill Joy? I’ll side with Richard Feynman and the multitudes who’ve followed in his footsteps before I side with a bunch of granola-munching mamby pambies who’ve made it their lifework to criticize humanity. Again: Can investors make money? Is nanotech a commercial technology? The answer is yes. Look at Nano-Tex, for instance. Nano-Tex has licensed its nanotechnology of the same name to more than 20 textile mills around the world. In fact, it’s widely credited with saving Burlington Industries from extinction. Nano-Tex renders fabrics impervious to the klutz factor without changing their feel — unlike Scotchguard and other fabric treatments. If you’re wearing shmattes from Eddie Bauer, L.L. Bean, Gap, Old Navy, Nike or Champion, you’re probably wearing nanotech. You of all people, Irwin, should feel the joys of Nano-Tex. If your pants were Nano-Tex-treated, that apple juice you seem to have spilled on your pants would’ve rolled right off…that is apple juice, right?

IG: Actually, Carl, it’s champagne, which I’ll renounce immediately if I ever find out that those precious tiny bubbles have been nanoized. Say what you want about the French, but never in a million years…

CW: Put down that frog bubbly and try numbing the pain with Flex-Power — another viable nanotech company. They make this joint and muscle pain-relief cream that’s “powered” by liposome-delivery nanotechnology. It’s endorsed by a growing list of professional athletes: the Nets’ Jason Kidd, the 49ers’ Andre Carter and Jeremy Newberry, the Browns’ quarterback Jeff Garcia, Lorrie Fair of the U.S. Women’s World Cup soccer team, former slugger Hank Aaron — and a growing list of armchair athletes with Budweiser elbow. These pros not only swear by the stuff — they invest in it.

IG: Yeah, and they also use steroids. Now here’s the rub — no pun intended — when it comes to nano-enhanced drugs. It’s something called the FDA. If the folks who brought us Celebrex, BEXTRA and Vioxx reject the approval of a nano drug, the company’s stock will tank quicker than the Titanic. This is not speculation. Because the University of Massachusetts conducted a study that showed that for 41 public companies whose new-drug applications were rejected by the FDA in the 1990s, their stock dropped an average of 11.2% the next day…and another 5.9% the following day.

CW: There are risks in every business. If you’re not willing to take on any risk, you shouldn’t be in the market at all. Just stuff your green in the mattress and go play some golf. Speaking of which, another nanotech company, NanoDynamics, makes a golf ball that, while it won’t correct a 45-degree slice, will fly truer than a Titleist. Thanks to nanotechnology, NanoDynamics’ golf ball absorbs the energy from the golf club and helps correct for rotation and drift. Combine that golf ball with the New Majesty driver, courtesy of Maruman, and you’ll have nobody to blame but yourself. The New Majesty is made of nano-titanium materials called fullerenes. It’s harder and more resilient than plan ol’ titanium, so it bends less and drives farther. And Maruman — a Japanese company, by the way, so nanotech’s not just an American dream — has had difficulty keeping up with demand.

IG: Sounds like James Boric could use those amazing balls.

CW: I’ve already placed the order. I’ve got a little something for you, too, buddy: NANO SKIN TECH. This is skincare specialist BioNova’s nanotechnology, and it’s at the forefront of a trend that extends beyond skin care into other areas of health care: the trend toward personalized medicine. BioNova’s lab coats consider such things as age, sex, race and lifestyle when they mix up a personalized skin care solution for a customer. And by the way, NANO SKIN TECH accounts for half of BioNova’s sales. I’m tellin’ you, Irwin, nanotech can have you looking as good as you ever will. Just remember: They’re not magicians.

IG: I harbor no illusions. Neither should investors. Those firms are all privately held, aren’t they? They may prove commercial viability, but what about investors?

CW: Well, for that, we’ll have to look at the nano tape. There are currently three nanotech plays in The GRIP portfolio. One is a nanotech pure play, a licensor of nanotechnology that also holds the rights to the single most important nanotechnology patent, according to patent attorneys Donald J. Featherstone and Michael D. Specht of Sterne Kessler Goldstein Fox. Shares of this nano-tot are up 42% since Dec. 28. The second GRIP nano-play is in the energy field; it’s up 22% during the same time frame. And the third is a long-time GRIP fave with an intellectual property portfolio of more than 100 patents and patents pending. This little engine is purring in nanotech’s sweet spot, the convergence of biotech and nanotech. It’s up 44% since Nov. 30 and 1,092% — you heard me right — 1,092% since becoming a GRIP pick, way back in May 2001. The lesson here? Do your due diligence, exploit the trend early, and hang on for the ride.

IG: I admit those are great numbers, Carl. But uninformed investors can come dangerously close to sinking their money in the next potential Nanosys. If that company had ever managed to go public..well, it’s just too horrific to even think about it.

CW: Sure. Look, it’s important to do your homework. Venture capitalist Alex Wong of Apax Partners has reviewed hundreds of potential nanotech investments, but has invested in only two. So yeah, as with all investments, due diligence is the first step. As for Nanosys, the fact is Nanosys did the right thing. The Nasdaq had plunged about 8% the previous month (July 2004), the worst monthly performance in nearly a year and a half, and 14 of the 28 companies that had come to market in July fell below their IPO prices. I’d be more concerned about Nanosys and its management if they’d plowed ahead anyway, despite the frosty market conditions.

IG: By the way, in the spirit of due diligence, I’m assuming you read that piece.

CW: Yes, of course I read it. I almost always agree with what you say, which is why I was so blown away by the huge miss here. To dismiss an entire industry — its underlying technology, its commerciality, its investment potential — on the basis of one pulled IPO… Well, I expected more than horse-and-buggy thinking from the proud owner of a Beemer. And that “tale of dread” of yours isn’t nearly as scary as the overblown reaction to it: There are, after all, inherent risks to any business. Am I to assume, Irwin, that in addition to nanotech, you’ve stricken medical device makers, REITs and wireless technology from your potential investment list as well? Because companies in each of these industries pulled their IPOs on the very same day. At this rate, you’ll have us all investing in tulips again.

IG: Not exactly, Carl. I fall in with Chris Mayer, editor of Fleet Street Letter, who has made 67%, 76% and 117% by investing in companies with “assets that sweat.” That’s why I’ve written about small-cap companies such as railroads, manufacturing and, speaking of sweating…diet foods — the kinds that you drink and eat using our God-given teeth and gullet.

CW: Oy! You’re exhausting. Chris is no slouch, that’s for sure. But as for your nanotech paroxysm, only if we set aside all the evidence can I admit that you have a point. Not a nanopoint, though — something even smaller…one of those top quarks or muons or such things — those tiniest of the tiniest of particles that, much like your argument, are here for the briefest moment only to evaporate into nothingness.

March 01, 2005

Nano Smack-Down: The Penny Sleuth v. The Gripper was originally featured in the Penny Sleuth.

*** I don’t know what the heck has come over me today.  Maybe it was my weekend in New York. I saw Christo’s The Gates, grabbed a cab to the Second Ave. Deli for an incredible corned beef on rye, then back uptown to see Billy Crystal’s one-man extravaganza “700 Sundays” and overall just walked around the Big Apple with my wife, bracing ourselves against the bone-chilling cold with the occasional Irish whiskey.

But whatever happened, I got a bad case of rumor-mongering. So look out Gripper, Sala and Chris, because there’s no stopping me…

*** Carl (The Gripper) Waynberg has finally done it. He’s challenged me to a nanotech “smack down” and I’ve accepted his puny dare.  I don’t care how much you’ve made for your readers, Gripper. I’m going to lay waste to the very notion that anyone can make a red cent in nanotech. In fact, in this very issue, I dispel the mass hysteria about one of the biggest nanotech IPOs that never was: the dreaded Nanosys. Any time, any place, Gripper. BRING IT ON!!!!!!!

I’m telling you now, Gripper, I’m not at all intimidated by your great track record. So what if your recommendations made 217.43%, 110.14% and 261.35%? So what if you know Bruce Willis? And so what if you answer your readers email, PERSONALLY? Because when I get done with you, you’ll be begging for mercy.

So stay tuned, small-cap smack down fans, as Carl and Irwin hurl stock symbols at each other like folding chairs in a Fear and Greed event coming to your PC soon. In the mean time, if you want the Gripper’s tale of the tape, you’ll have to go to www.the-gripper.com.

*** Sala Kannan has a great idea, and we’re “running” with it…and you’re the first to know. She’s going to be running stock screens for us two or three times a month. Sala has figured out new ways to slice and dice the small-cap market to reveal the best (and worst) companies in a new light.

Some screens you can expect from her include small-cap cash cows, fund-managers favorites or the 10 small-cap stocks to dump now. Even though you’ve been reading Sala on a regular basis, maybe one of the things you don’t know about her is that she really did graduate from Cambridge University with a masters degree in economics.

I don’t know about you, but if I had anyone run a screen for me, it would definitely be Sala.

And speaking of my esteemed colleagues…

*** This morning, while I was making a cup of coffee in our company kitchen, I ran into Chris Mayer. As you Sleuthers know, Chris is editor of The Fleet Street Letter and a regular contributor. I’m proud to run his essays because he is one of the brightest guys I know. I’d heard that Chris was up to something really big, and I asked him about it…or should I say pried it out of him (Chris is also quite modest). Chris started to explain it to me, and my jaw dropped.

After we finished talking, I ran up the three flights of stairs to my PC…because I had to let you know ASAP. Here’s the scoop: this Friday, Feb. 25, Chris is introducing a new service. I can’t divulge the name of it right now, but I can tell you this…

It’s based on a 100-year-old trading system that beats the pants off “buy-and-hold” while dramatically slashing your exposure to risk. Chris’ system identifies three crisis points in a stock. When they all line up, you execute the trade…while the rest of the herd on Wall Street is stampeding in the opposite direction. Chris’ ability to spot a deal that others don’t is the main reason that he was the vice president of a bank before the age of 30. In fact, the bank never lost a dime on any of the massive loans that Chris approved.

Apparently, our publisher Addison Wiggin is getting ready to email you something soon.  Please read it, because it will include a special 14-day offer to Chris’ service. I believe that once you find out more about this new opportunity, you’ll be completely blown away by the amount of money you could pocket. Just don’t say I didn’t warn you.

*** As I mentioned, Nanosys is in my cross-hairs. I came across an SEC document for the yanked Nanosys IPO. Check it out. If you believe all the nutty hype about making a fortune in nanotech, the information that I’m going to share with you will turn your blood ice cold…

No-Go Nano

If you’re a fan of horror stories, then forget Steven King, Peter Straub or Richard Matheson. Because I found one that will make your blood curdle, bring on night sweats and make you swear off those teeny-weeny hobgoblins that croon sweet ditties of fortune and paradise — only to suck you penniless.

This tale of dread is to be found in the SEC Form S-1 registration of Silicon Valley’s Nanosys, Inc. — the most ballyhooed nanotech IPO that never was. After reading it, you ask yourself, “How did it all get so out of hand?” I mean, the S-1 is a public document, designed for corporate disclosures. It includes typical boilerplate information regarding use of proceeds, management and dilution. But in the Nanosys S-1 of April 22, 2004, it was the section “Risks Relating to Our Business” that caused my hair to stand up.

It was like being absorbed in a story about newlyweds wandering the forest during a late- night thunderstorm…when they stumble upon a creepy castle. As they approach the imposing gate, wolves howl, and you think to yourself, “Don’t do it, don’t do it.” But they keep approaching it, pound on the monstrous door — and as they wait there shivering and frightened, you wonder, “What the heck are they thinking?”

Leading up to its proposed IPO last year, Nanosys was hailed as the breakout company for the fledgling nanotech industry. What Netscape’s IPO had been to the Internet, Nanosys would be to nanotech. Nanosys would finally prove that Wall Street, K Street and Main Street were ready to bank on companies that built things measuring in nanometers, or 1/100,000th the diameter of a hair. Smart money was betting that it would be inevitable…

The company had partnered with Intel, Matsushita and DuPont. Through them and leading universities, Nanosys had either acquired or had applications pending for more than 250 patents. The $2.5 million in revenue it had booked for the first half of 2004 stemmed from R&D contracts with its partners. During that period, though, Nanosys had lost $8.8 million — 252% more than it had earned.

Based on its own fallacious merits and the meteoric success of other nanotech IPOs such as Nanophase Technologies, Altair Nanotechnologies and Flamel Technologies, Nanosys was expected to raise $94-101 million by selling shares valued at $15-17 each.

Then there would come the big bang in nanotech…a construction boom in factories (only visible through scanning electron microscopes), which would spit out devices about the size of a human blood cell for every imaginable application — and in the process make huge fortunes for investors and insiders.

Nanosys had been on everyone’s lips, the buzz amplifying in 2003 after President George W. Bush signed the 21st Century Nanotechnology Research and Development Act. It allocated $3.7 billion for nanotech R&D between 2005 and 2008. The bill also endorsed the industry as a whole — hastening along the Nanosys IPO…despite the gory details in pages 15-28 of its S-1.

Reading them will scare you silly. You will never invest one thin dime in newly public nanotech companies — or for that matter, in anything nanotech. Because the chilling risks it discloses are, in fact, TYPICAL OF THE INDUSTRY. This section of the Nanosys S-1, however, is a greater cautionary tale of nanotech IPO zombies that haunt the corridors of Wall Street.

For example, some disclosures include…

A history of losses starting from its inception. As of Dec. 31, 2003, the company had burned through $17 million — and that was just for 34 employees at the time. The company also warned that because it was deploying new technologies, it might not
be able to develop any products at all. Certainly a credible concern, since Nanosys had yet to develop any products on which to build a sustainable business.

Product revenue depended on market acceptance, the company explained, but the markets being targeted had never adopted a nanotech product, and there was no guarantee that they would. Hmmm…

Even if they had the full cooperation of their partners, which the company couldn’t guarantee. That means Intel, DuPont and others could not assure Nanosys that it would supply a real-world environment to test, sell and manufacture the products — essentially leaving commercialization of Nanosys’ creations to one’s imagination.

So Nanosys could be forced to manufacture its own products. But — by the way — it had demonstrated the ability to do that.

The situation gets much worse once the S-1 delves into licensing arrangements. Since Nanosys licensed much of its core technology from research institutions such as Columbia University, Harvard University and UCLA, the company’s freedom to refine these technologies depends on the license. Royalties would also be affected by the terms of these agreements, depending on corporate milestones, revenues and the number of patents covered by the contracts. In short, Nanosys has given up considerable control of the evolution, profitability and pricing of its products in order to reach a broad number of markets.

And finally, even if Nanosys were able to wrest a viable commercial product from these Byzantine pacts, it still would have faced direct competition from its formidable industry partners — finding itself in a David-and-Goliath battle in which Goliath had full access to David’s puny battle plan.

On Aug. 4, 2004, citing “adverse market conditions,” Nanosys yanked its IPO. So in the end, Nanosys was a no-go. A happy ending to a scary nanotech tale for small-cap investors.

Happy investing,

Irwin Greenstein

February 22, 2005

No-Go Nano was originally featured in the Penny Sleuth.

*** I talked to my cousin Michael last night via instant messenger. He said he was fed up with his current living situation and wants to start up his own business. So I asked him what he wants to do.

“I’m not sure if it I would start my own property management company or run an ambulance service business. But it has to be a service, I know that. And I’m leaning towards the ambulance gig. After all, there are millions of baby boomers. And eventually, they will need an ambulance…for something.”

Michael went on to say…

“Hell, my cousin runs an ambulance company — and he’s a dumbass. He has the business sense of a baboon. Yet he does very well for himself. And I’m a workaholic. If I planned this out right, I am pretty certain it would work out nicely.”

Your Penny Sleuth was intrigued. Michael’s argument made sense to me — in a sophomoric sense. Of course, I would never go into business for myself until I’ve thoroughly researched the risks and rewards of the industry. And I wouldn’t base my chances for success off another “dumbass” cousin who happened to walk into a gold mine. But there just may be something to Michael’s logic.

Fist of all, services make up about 80% of our nation’s GDP. And Unz & Co., an international trade expert that opened up shop in Manhattan in 1879, says…

“Looking into the future, the service sector looms ever larger in the U.S. economy. This services-driven business expansion is overwhelmingly led by small, entrepreneurial firms, those firms employing fewer than 500 employees. Small services companies account for more than 41 million jobs.”

Second of all, the total number of Americans who are 50 years or older is expected to grow as much as seven times over in the next 15 years. And according to the Federal Reserve Board, these baby boomers account for 70% of the net worth in our wonderful country.

Sounds like Michael may have an idea worth looking into. So I wondered, is there a way to make money off this idea on Wall Street?

Turns out, there is a fund manager who is thinking just like Michael.

*** Robert Male’s Buffalo Small Cap Fund beat 97% of all mutual funds last year, rising 29%, according to Danielle Kost of Bloomberg News. In fact, over the last five years, the fund has averaged 17% compounded annual returns. Not too shabby. During that same time, the Russell 2000 index has averaged 4.64% gains.

So how has Male managed to beat the rest of the market?

Simple: He looks at major demographic trends developing in the United States, and he invests in companies that should directly benefit.

According to the Bloomberg report I read, “Baby boomers, those born between the end of World War II and 1964, accounted for about 28% of the U.S. population in 2000, according to the Census Bureau. People under the age of 18 made up 26% of the population in 2000.”

Those are some pretty large trends — which is exactly why Male invested about half his $2 billion in assets in consumer and health care companies like Pharmaceutical Product Development – a drug discovery company — and INAMED Corp. — which makes breast implants for those not quite happy with their God-given busts.

Personally, your Penny Sleuth doesn’t understand why anyone would want silicon balloons in her chest. But that’s neither here nor there. The point is…

As investors, those with a well-crafted plan and the guts to stick by it through thick and thin should outperform the rest of the herd. Male has certainly proved that.

In 2002, his Buffalo Small Cap Fund lost 26%. But he didn’t panic or start blaming people for his “failure.” Rather, he stayed invested. He had a longer term horizon than most investors. And it paid off. In the last three years, his total assets have grown from $770 million to $2 billion.

Speaking of a picture of health…

*** My colleague Chris Mayer, editor of Fleet Street Letter, wrote in saying, “I am bullish on a company with concrete slabs with 300% profit margins. This company owns 120 hydroelectric dams on various river systems located primarily in the United States and Canada, and also in Brazil — essentially, concrete slabs that ooze with profit.

“The operating costs of these dams run about 1 cent per kilowatt hour, and the company charges about 4 cents per kilowatt hour, making it one of the lowest cost producers of electricity in North America.

“There is much more to this company, virtually a cornucopia of wealth-generating assets. For example, the company owns over 40 million square feet of prime office property in the business hubs of North America and London, among the most expensive real estate in the world.”

*** At Penny Sleuth we’re going to keep trying to spot the big trends for you — so you can maximize your own investment returns. In fact, I am working with Angela Roberts, the editor of Penny Stock Fortunes, on finding a company that will benefit from the aging baby boomers. More about that in coming months. But for now, Irwin talks about getting phat…

Get Phat on Diet Small Caps

I never make New Year’s resolutions. I’ve always figured that if I worked hard, stayed focused and got the occasional peck on the cheek from Lady Luck, things would go my way. But on New Year’s Eve 2004, surrounded by friends at a swanky party in a Victorian mansion with a view of its lighted swimming pool and carriage house, I broke
down and did it — becoming another statistic in an industry ripe for small-cap investors.

Having gorged myself that night on appetizers of caviar, sour cream and chopped eggs on miniature potato pancakes, along with toasty baguettes with pate and stinky cheeses…followed by glazed ham, crispy duck with plum sauce, beef bourguignon, leg of lamb, grilled sea bass, garlic mashed potatoes, candied carrots, and asparagus almandine in lemon-butter sauce…and then shoveling in flourless chocolate torte, carrot cake with thick cream cheese frosting, apple pie and petits fours…all washed down by a river of Veuve Clicquot champagne and Germain-Robin cognac…as the poppers, kazoos and streamers burst through the house at midnight…my belt at the very last notch feeling like a deadly garrote around my waist…I took the leap and vowed to lose weight in 2005.

Even though I’m a bit porky, it could be worse. There are many Americans who really are in awful shape. Of all adults, 64% are either overweight or obese, according the National Center for Health Statistics. One in eight deaths in America is caused by an illness directly related to overweight and obesity. And obesity contributes to our nation’s biggest killer: heart disease.

Personally, I fall into the category of someone who finds that 25 pounds have snuck up on him over the years. So New Year’s Eve becomes a momentous occasion for turning back the clock on my waistline. And I wasn’t exceptional that night. WABC Eyewitness News of New York conducted a poll that showed 46% of those surveyed said their New Year’s resolutions for 2005 involved dieting.

But my pain is usually someone else’s gain — and it might well be yours. Because one of the best-kept secrets for small-cap investors is that there are a handful of undervalued companies supplying supermarkets, health food stores and doctor’s offices with diet foods and weight-control programs. And they offer a great way for you to get phat.

As you can imagine, the U.S weight-loss market is huge (no pun intended). Here are few tasty figures to chew on, courtesy of Marketdata Enterprises…

Medically supervised diet programs, which rung up $2.12 billion in 2002, will increase to $2.44 billion by 2006 — up 15.1%. Retail and multilevel meal replacements and appetite suppressants will soar 47.9%, from $2.38 billion in 2002 to $3.52 billion by 2006. And diet soft drinks, which produced $14.86 billion in revenues in 2002, will grow 12.8%, to
$16.76 billion, in 2006.

But don’t jump to the obvious conclusion that the carb-starved minions of the Atkins and South Beach diets are dominating the market expansion. Recent data indicate that those trendy weight-loss regimens may have already peaked…leading an army of disenchanted dieters back to time-proven organizations like Weider Nutrition Intl., Medifast, Inc. and NutriSystem, Inc.

This may come as a surprise, but a study by the American Institute for Cancer Research showed that low-carb dieting ranked third behind the old-fashioned approaches of increasing produce and decreasing fat intake. In another study, independent market researcher NPD followed 11,000 low-carb fanatics in 2004 and discovered that by year-
end only 25% reported that they were still “significantly cutting carbs.” Meanwhile, of the 1,100 people interviewed by Opinion Dynamics Corp., between December 2003 and August 2004, 11-12% said they were on a low-carb program…that number shrinking to 8% by October 2004.

While that’s bad news for the Atkins estate, it’s great news for us, as more tubbies flock to our low-flying, small-cap trio of diet food providers.

When it comes to Weider, Medifast and NutriSystem, I think of them as polyester perennials…because like polyester clothes, they’re mass marketed and fad resistant — and they make their manufacturers (and shareholders) gazillions of dollars.

For example…

Weider sells about 50% of its beverages, snack bars and supplements through mass-market superstars Costco and Wal-Mart. While you won’t see Weider’s stock price seesaw like so many diet fads, its revenues have been consistently growing. Let’s look at the most recent earnings…

For the second quarter of 2005, Weider’s net sales were $67 million, up a commendable 10.2% from the same period last year. And commensurate net income was $3.5 million, versus $2.7 million — an impressive increase of 29.6%. For the six months ended Nov. 30, 2004, net sales came in at $136.7 million, compared to $124.4 million the same fiscal period of 2004 — or a respectable rise of 9.9%. For the first six months of fiscal 2005, Weider reported a net income of $7.2 million, compared to $4.9 million for the comparable six-month period in 2004 — an incredible improvement of 46.9%.

With these kinds of numbers, you’d think that Weider’s stock price would be shooting the moon. But if you look at its 52-week performance, it’s down 0.22%. That’s the bargain basement, where you have to dig through heaps of polyester “fashions” to find the real gems, including…30-year-old NutriSystem.

NutriSystem supplies its customers with online and phone counseling that supports meal programs delivered to the doorstep. The company has a distribution/sales deal with QVC, whose reach is some 86 million American homes, 13.1 million households in the United Kingdom, 34 million homes in Germany and more than 11.6 million homes in Japan. That’s a lot of couch potatoes.

The most recent financial report to come from NutriSystem was dated Feb. 1., when it issued a press release for its first-quarter 2005 outlook in anticipation of Feb. 23 earnings.Gazing into its crystal ball, the company expects a 100% revenue increase year over year. If that’s the case, we’re looking in the neighborhood of $26 million, up from first quarter 2004′s $13.2 million (which represents an 85.9% increase from the first quarter of 2003).

Let’s review NutriSystem’s most recent full reporting period, the third quarter of 2004. Revenues hit $7.6 million, a 58.3% surge from the $4.8 million recorded in the same period of 2003. Unfortunately, net income didn’t seem to stack up: For 2004, the third quarter netted a paltry $121,000, versus a net loss of $225,000 for the same period in 2003. True, that is a 153.8% jump. But it also shows that the company is spending a fortune on marketing and customer acquisition to gain mind share from the media’s low-carb blitz.

With a 52-week stock pop of 141%, NutriSystem could still be considered a deal as it currently hovers under $6. For bargain hunters, driving the top line without a corresponding upturn in the bottom line could leave this stock dragging for a while…like a pair of polyester slacks in need of a big hem.

If we keep digging into the bargain-basement heap, we’ll eventually find 50-year-old Medifast. With a 52-week stock drop of 63.2%, it may reek a bit, despite some high-quality features.

Medifast’s beverages, snacks and soups augment a balanced diet of home cooking fare. The program is sold through 15,000 physicians, Medifast weight loss centers and the company’s Web site. Despite an affiliation with Johns Hopkins University, things started to unravel quickly at Medifast — much like pulling a thread on a cheap polyester sweater.

Given the herd mentality of Wall Street, it was Seidler Companies’ analyst David Block who led the stampede on Medifast’s big sell-off. When Block initiated coverage of Medifast on Oct. 1, 2003, he had opened with a “strong buy,” targeting $18 on the day that the stock closed at $11.60 — meaning that he expected the stock to eventually turn a profit of 55.2%.  The stock fulfilled Block’s projection on Nov. 6, hitting a high of $18.75 and closing that day at $18.49.

After that, as Medifast consistently missed earnings, Block hammered the stock…going from a “hold” on March 16, 2004 to his first “sell,” on Aug. 17, 2004. Generally, Medifast was increasing top-line revenues while net income was dramatically deteriorating. Estimates to the analysts kept dropping. Essentially, Medifast was spending millions on TV advertising, but Wall Street wasn’t impressed with the results.

The big problem was that Medifast was completely swamped by the enormous response to its ad campaigns and couldn’t follow through on all the leads — losing millions in potential sales.

Looking back at Block’s first “hold” rating, it coincided with Medifast’s fourth-quarter 2003 report, in which revenues surged to $6.7 million, from $3 million during the same period of 2002 — up 123.3%. Reading down the company’s 10Q statement, things get ugly. Net income dropped to $520,000 in fourth quarter 2003, from $1.54 million in the
same quarter of 2002 — a tumble of 66.2%.

The stock closed at $3.33 on Feb. 14, 2005, due to poor execution. Still, with a world-class manufacturing facility, a switch from TV to direct marketing and a huge customer base, Medifast has lots going for it.

I wish that I could shed as much weight as Medifast has value. Since the beginning of the year, I’ve lost about 5 1/2 pounds. I’ve given up my morning muffin and cut back portion sizes (except the booze). My approach, though, is to take the long view and lose 10-15 pounds over the course of the year. And when it comes to Weider, NutriSystem and Medifast, you may want to consider the long view as well.

Happy investing,

Irwin Greenstein

February 15, 2005

Get Phat on Diet Small Caps was originally featured in the Penny Sleuth.

*** Investors can’t make up their minds if they are bullish or bearish on small-cap stocks. While I was in Orlando last week for the World Money Show, hedge fund managers and major institutions dumped $247 million into the Russell 2000 — as the market showed signs of strength. Now it seems they have changed their minds.

According to TrimTabs’ latest inflow/outflow report, $220 million of so-called “smart money” has exited the Russell 2000 in February alone. That means our favorite small-cap index just lost about $400 million in the last week. Poof, gone — just like that.

But I guess we should have seen the fall coming…

*** For weeks now, my partner in crime, Irwin Greenstein, has been telling you stories of the booming (read “out of control”) IPO market. That’s a clue to us small-cap investors.According to small-cap experts Christopher Graja and Elizabeth Ungar, “Since IPOs almost always have limited market capitalizations…they serve as a litmus test for the small-cap market in general. Companies typically do IPOs when the think the market is riding high enough to bring them a good price for their shares. If many issuers start rushing to market, they may be exploiting a window of opportunity before it closes. In other words, small caps may be due for a correction.”

Translation…

When terrible companies can sucker investors to lay down enough money to allow them to go public (read:personally cash out for big bucks), you should be wary. And that’s exactly what is happening right now.

Of the 13 venture-backed IPOs that hit the market since Jan. 28, eight of them have lost ground from their first-day close. The biggest loser was Chinese Internet company Hurray! Holding Co., which is down 12.2%. Not following too closely behind it was biotech sensation Icagen, which was off 6.6%. After that, the losses were somewhat minimal.

But are we really in an IPO bubble? I think so.

*** In all of 2003, only 79 companies IPOed. In 2004, 233 companies made the jump from the private market to the public. That’s a 195% increase. In fact, there were more IPOs in 2004 than all of 2002 and 2003 combined. Smells like a bubble, looks like a bubble and probably even tastes like a bubble. So let me be clear…

We are in an IPO bubble!

If Graja and Ungar are right about the correlation between IPOs and the small-cap market, the Russell 2000 may have peaked for a while. And companies that didn’t deserve to rise last year will be punished this year.

If you want my prediction for the small-cap sector most likely to be bashed, I’ll give it to you…

I predict small-cap REITS will be hit the hardest.

*** In 2004, 15% (or 12 of 80) of all the IPOs that hit the market in the fourth quarter of 2004 were in the real estate industry. So that seems to be the place where most people (read “poor, misguided souls”) are placing their money.

Anytime the herd moves in one direction, it’s time to get out.

*** You may have seen my essay in The Daily Reckoning yesterday — titled “The Specialization of Insects.” It was my follow-up message about the great debate that my buddy Dan Denning and I had in Orlando.

In case you missed it, Dan and I were going back and forth about whether or not you could find value in the U.S. markets. He said it may be hard. And I said there will always be value in the small-cap market — if you are willing to look…maybe even dig deep. Well, a fellow analyst chimed in yesterday. Dan Ferris, editor of Extreme Value, wrote to me and said…

“As for the question about value, anyone who’s done the work will tell you there’s nothing to debate: There’s plenty of value out there in small-cap land. I’ve got 50 names on a watch list for my own money. I own five of them right now. A typical stock I like sells for $8.50 and has $22 a share in cash and government bonds, no debt, is profitable every quarter, owns its whole market. Another one has $71 per share in cash and securities and a consistently profitable business, and it’s going for about $47 a share today. Another owns $20 million in real estate, holds no debt, plus is a business easily worth $30 million, the whole thing selling for about $35 million, and pays a regular dividend, too. One has $10 a share in cash, no debt, real estate worth probably $50 a share and a profitable engineering business. The whole thing goes for $24 a share. There are a couple dozen others similar to that. You’ll never, ever find them above $250-$300 million in market cap. Because they’re often closely held, there’s usually no option overhang, either. Not only is there value in small caps, but there’s more value there than anywhere else, and probably always will be.”

*** The truth of the matter is…

Dan Denning, Dan Ferris and I are all right. It is harder than it was three years ago to find value in the small-cap market. But as Mr. Ferris points out, there are a lot of opportunities to make money…always have been and always will be.

I only hope you will continue to read Penny Sleuth as we continue to explore where those opportunities are…and where they are not.

In terms of value, Irwin tells us why small-cap software companies are getting crushed.

Small-Cap Software Meets the Crusher

Picture a junkyard car crusher whose four steel walls exert pressure at 2,400 pounds per square inch. One wall is labeled “off-shore outsourcing.” Another wall says, “giant software companies.” A third wall reads, “open source software.” And on the fourth wall is written “deep discounts.” Into the crusher jumps the CEO of a small-cap software company. When the switch is thrown, the walls creep toward him.

Unless you want to join our doomed CEO, don’t buy shares in his company. That’s because small-cap software vendors that develop products for front-office applications (desktop productivity tools) and back-office applications (databases, e-commerce servers, payroll) are facing marketplace pressures that make them less desirable investments than even two years ago. And the squeeze is expected to last for the next three years at least.

Many small-cap software companies are getting destroyed by the very same forces that have shaped the entire tech industry: rapid innovation, increased competition and loss-leading products. But what’s really different today from a couple of years ago is that small-cap software companies are losing their influence with customers…and consequently, the leverage to demand the high-margin prices that they traditionally savored.

Historically, software vendors operated from a position of strength with their customers. If a business application could deliver real value, its widespread installation would eventually hold the customer hostage — giving the software vendor power to force-feed upgrades and training and maintenance packages. But since the tech bubble burst, the tables have turned.

That’s because corporate chief information officers are still digesting their 1999 grande bouffe of overpriced, overhyped software. Worse, the big IT budgets that had peaked from the Y2K fiasco and the Internet Revolution have not returned. So CIOs who are stressed out by a reduction in resources and relentless cyber attacks are no longer tolerating the arrogance of their software providers.

How bad is the problem for small-cap software companies? In December 2004, META Group, a technology consulting firm to both vendors and corporate users, laid out a gruesome scenario.

The ominous trends that META identified include software industry consolidation of 35% by 2008 (exerting agonizing pressure on undercapitalized software companies), competition from low-cost offshore developers that is expected to grow 20% annually through 2008 and declining prices for the first time in a decade over the next 3-5 years.

And the price wars are getting worse..starting with the biggest software companies and trickling down to the most vulnerable competitors — small-cap software providers.

For instance…

Documents pertaining to Oracle’s hostile takeover of PeopleSoft revealed that customers were able to extract discounts from both companies of up to 90% on the published list price.

If a small-cap software company must compete against a 90% discount, what about competing against software that’s free?

Called “open source,” it is developed free of charge by a global community of dedicated coders. While “free” is somewhat of a misnomer, the software is generally available for downloading off the Internet at no cost. It’s not exactly free because the CIO’s staff must then modify and maintain the software. Still, it’s usually much cheaper than comparable applications purchased directly from a software company.

Open source software has clearly penetrated the hallowed data centers of the largest corporations. It runs on servers, desktops and databases. Even IBM and Hewlett-Packard have launched multibillion-dollar open source initiatives as a means of cutting software prices — and opening doors for lucrative service contracts that can shut out a small-cap
competitor.

Of all the elements that make up a computer system, software is the easiest to discount. That’s because the purchase price can be marked down to lure investors into lucrative add-on sales that keep the applications current and reliable. And the very nature of software’s widespread presence in a corporate infrastructure means that major vendors can make up the loss through consulting and integration services that are too far-reaching for small-cap companies to compete against.

This became abundantly clear when IBM, for example, announced its 2004 fourth-quarter earnings.

The company’s revenues were up 7%, to $27.7 billion, from $25.9 billion in the same quarter in 2003. Specifically, revenues for IBM’s fast-growing Global Services consulting unit had increased 10%, to $12.6 billion, and it is sitting on a backlog of $111 billion. Why is this important to small-cap software companies?

IBM’s Global Services arm provides consulting and integration expertise that helped drive the company’s $4.5 billion in software sales for the quarter, a 7% increase over the fourth quarter of 2003. The added value of a full-service software provider becomes abundantly clear when looking at revenues of IBM’s WebSphere software, which
interconnects applications, data and the operating systems that drive the computers themselves. WebSphere revenues were up an amazing 18% over the same quarter in 2003.

Importantly, IBM’s return on assets is high at 8.19%, while its return on equity is a phenomenal 29.2%. Remember these numbers, because they become important when considering the long-term viability of small-cap software investments.

For example…

On Feb. 3, Ascential Software Corp. announced results for the fourth quarter. For this provider of software for sharing data across large corporations, revenue surged 21%, to $78.2 million, from $64.5 million in the same period of 2003, while net income plunged. For the fourth quarter, Ascential’s net income was $2.4 million, versus $17.3 million for
the fourth quarter of 2003 — a decline of 86.1%.

If you look at the company’s third-quarter 2004 results, its revenues rose 47%, to $67.6 million, from the same year-ago period. Net income increased 235.3% to $2.3 million from a $1.7 million loss posted in the third quarter of 2003.

The company’s second-quarter 2004 revenue was $64.7 million, up 62% from $39.9 million in the second quarter of 2003. Net income was $1.2 million, compared with net income of $700,000 in the second quarter of 2003 — or up 71.4%

But check out Ascential’s return on equity and return on assets. Its ROE is a crummy 2%, while its ROA is 1.59% (ouch).

Now, before you accuse me of making an apples-to-oranges comparison, this is highly justifiable when you transpose it to Ascential’s stock performance. The 52-week change for the stock is MINUS 33.7%.

Informatica Corp. is another shocker. The small-cap company sells data integration software that helps companies make their information more useful across systems that would otherwise be incompatible.

Informatica’s revenues for the fourth quarter of 2004 were $60 million, up 6.8% from the $55.9 million recorded for the same quarter in 2003. That’s certainly better than a poke in the eye with sharp stick, which awaits you when you read that the company’s net loss for the quarter was a whopping $105.8 million — a 97% drop from the $3.2 million net income posted for the same period in 2003.

Informatica’s revenues for the third quarter of 2004 were $52.4 million, up 3.4% compared with $50.6 million recorded in the third quarter of 2003. The company widened its net loss by an astounding 2,766.7%, to $8.6 million, from a net loss of $300,000 for the same period.

For the second quarter of last year, revenues were $53 million, a 4.5% increase from the $50.6 million posted in the second quarter of 2003. Net income for the second quarter was $1 million, down 69.7% from the $3.3 million in Informatica’s second quarter of 2003.

But comparatively, Informatica had a pretty good first quarter 2004. That’s when revenues had surged 10.7%, to $54.2 million, from $48.4 million in the same quarter the year before. The first quarter’s net income was $1.9 million, up an impressive 90% over $1 million during the first quarter of 2003.

As Informatica’s performance slipped last year, so did its return on assets, which was a miserable minus 27.1%, and its return on equity, a minus 42.6%. The company’s 52-week stock performance is a negative 21.5%. This is black hole territory, folks.

In examining the ROE and ROA of these small-cap software ventures, the story that comes out is of two companies reduced to competing on price and features — at a LOSS.

Informatica and Ascential are representative of small-cap software companies that were launched and went public before seismic shifts in the industry wrecked their strategies, business models and balance sheets.

Facing eroding margins, buyer’s remorse and angry customers, small-cap software companies providing front- and back-office solutions have found themselves in the crusher. The demolition will be long and painful — with their ROE and ROA taking the brunt of it.

So when it comes to investing in small-cap software companies, the first thing you should do is turn off your computer…and then grab a cup of coffee.

Happy investing,

Irwin Greenstein

February 11, 2005

Small-Cap Software Meets the Crusher was originally featured in the Penny Sleuth.

*** “You have to be an idiot to specialize in just one thing – whether it’s the small-cap market, or even the U.S. market.”

That’s what Strategic Investment editor Dan Denning said to me last week in Orlando at the World Money Show.

Dan and I, along with Chris Mayer and Addison Wiggin, participated in a panel discussion at 8:00 a.m. to debate the best investment strategies for 2005.

Mr. Macro himself, Dan Denning, argued that you can’t be good at JUST one thing in this market and expect to make money.

Globalization has made it a lot harder for individual investors to find bargains in the U.S. markets, Denning argued. In other words, the big money isn’t just flowing into the United States anymore. Countries like India, China, Brazil and many others are competing for the greenbacks as well.

After making that point (which your Penny Sleuth editor never disagreed with!), Dan made his move in the debate. I vaguely remember him calling me an insect of some sort…claiming that only an idiot would choose to specialize in any one part of the U.S. market.

Boy, did your Penny Sleuth editor go to town on that point…

I reminded Mr. Denning that specializing in JUST the small-cap market is hardly limiting yourself to one or two investment opportunities.

Right now, two-thirds of the market is made up of small-cap companies with a market capitalization of $1 billion or less. That means that as small-cap investors we have about 4,000 investment opportunities to choose from. Furthermore…

– 53% of the true growth companies on the market (those that are growing sales and net income by 10% and 25% Q over Q and Y over Y) are in the small-cap universe
- 26% of the real value companies (those that are trading at or below historic norms in terms of price to earnings, price to sales and price to book value) are small-cap companies
- 73.3% of all the companies on the U.S. market that have more free cash flow than total debt are small cappers
- 60% of all the companies that have doubled their earnings (or more) in the last year are in the small-cap universe.

As I told the audience in Orlando…

These are telling numbers. And specializing in the small-cap market is hardly like being a magician with ONE trick. We have thousands of opportunities to make money – always have and always will.

Then I turned to the audience for a question.

How many people think that small-cap stocks are legitimate investment opportunities right now in this market?

I expected a handful of people to raise their hands. After all, I speak all the time – all over the world. And I’ve NEVER seen a case where more than a third of the people believe in small-cap stocks the way I do. Most people still associate small caps with gambling and out and out speculation. But the answer I received in Orlando was unbelievable.

Every single person in the audience raised their hand. Some even raised two hands. I was shocked.

So what does this mean?

As a contrarian, when the crowd all thinks the same way, you want to do the opposite. So let me remind you (as I have ALL year long)…

Now is NOT the time to chase small-cap companies with little in the way of earnings and sales. Those companies WILL fall. And believe me, you do not want to be holding them over the next five years.

But…

As Chris Mayer and I argued in sunny Florida last week, even if thousands of small-cap stocks fall, there will be HUNDREDS that rise – doubling and tripling investors’ money. So to think that now is the time to pull out of the small-cap market completely is as ridiculous as saying you can’t find any bargains in this market.

You simply have to stick to your guns, invest in the smaller companies that are growing and trading for a value. Folks, those will be the companies that not only survive this year or next…but into the next decade and beyond. In fact, I am so sure of it, I made the audience a promise…

Ten years from now, I’ll come back to Orlando. And I’ll show you how many small-cap companies from 2005 are mid cap and even blue chip stocks today.

It would be a shame to miss out on those opportunities. So don’t.

*** And speaking of globalization, Irwin takes us from Cannes, France, to Baltimore, and on to Seguin, Texas, Rochester Hills, Mich., and Fairview, Ore., to show how American small-cap manufacturers are profiting from the strongest euro ever…

Dr. Kurt Richebacher has a burning conviction that Alan Greenspan is Satan incarnate. Richebacher’s anti-Greenspan inferno fuels a currency trading strategy whose recommendations have made investors up to 425% profits. As a straight-talking dollar bear with an Austrian accent, Richebacher never pulls punches, has an iron will and watches financial TV in three languages. In fact, Richebacher is so tough that some people think he eats nails for breakfast.

That’s why I jumped at the chance to have lunch the other day with my colleague Rick Barnard, who has been associate editor of The Richebacher Letter for the past five years. Rick had just returned from Cannes, where he stayed with Richebacher in his apartment overlooking the Mediterranean. Happy to finally sink his teeth into a thick cheeseburger at the local pub, Rick was saying that he and Richebacher talked nonstop about the economy – once in a restaurant over frog legs and oysters, where I’m sure Rick’s gag reflex was working overtime.

“Dr. Richebacher told me that he expects the euro to go up to $1.70 by the end of the year,” Rick said (a hint of Austrian in his voice). That means it will soon take $1.70 to buy one euro, versus $1.30 today. It also means that Richebacher is predicting a 31% decline in the dollar from current exchange rates – making the dollar downright anemic.

Now, before you pack up everything and head for Nicaragua, you need to know one important tidbit of information – one that I’m sure will come as a big relief. While Richebacher’s bearish forecast is great for his newsletter subscribers, it’s also a very hot opportunity for stateside small-cap investors.

Here’s the twist…

As the dollar weakens against the euro, American products become more affordable in Europe, while at the same time European products become more expensive in the U.S..This extraordinary currency weirdness gives American companies a big boost by making their products more competitive on both continents. The bad news, though, is that if you’re an American tourist in Paris, a cafe au lait will cost you about 25% more than it did a year ago – heaping on one more indignity to your trip.

It’s anybody’s guess how long these nutty economics will last. A lot of it depends on the U.S. budget and trade deficits, European tariffs that were imposed last year and an American border tax whose protectionist barriers have the European Union and the U.S. once again clashing before the World Trade Organization.

But in towns like Seguin, Texas, which is home to Alamo Group, Inc.; Rochester Hills, Mich., where DURA Automotive Systems, Inc. is headquartered; and Fairview, Ore., where Cascade Corp. has its roots, small-cap manufacturing companies are enjoying a windfall, thanks to the weakened dollar.

As bellwethers, these three companies make a convincing case for investing in American small-cap manufacturers that have a strong European presence. Because for them, it seems that business has never been better – at least while the dollars remains enfeebled against the euro.

In mid-April 2004, the National Association of Manufacturers projected that exported manufactured goods would show rapid growth into 2005 pegged to the dollar’s slide. The association followed up with a statement on Jan. 14, 2005, that concluded, “2004 was the most productive year for manufacturing in America since 1999.” The improvement in
output was partly attributed to “a realigning dollar [that] helped boost U.S. exports to record levels.”

For small-cap investors, the hitch is that top-line revenues may rise from currency conversions, but net income or earnings per share could remain unaffected. So that, for example, a $10,000 piece of heavy equipment could cost 31% more by year-end (based on Richebacher’s forecast), but generally accepted accounting principles will bake that into the final earnings for more accurate results. The bottom line is that higher international sales won’t necessarily translate into higher stock prices – near term.

Instead, the thinking goes like this…

Since a piece of heavy equipment from an American company is now cheaper in Europe, a new European customer will buy now based on price…but come back later for the quality.

To profit as a small-cap investor from the euro’s current dominance requires a buy-and-hold strategy – rather than a speculative flip. In other words, you’re not investing in a small-cap manufacturer with a growing European customer base simply because the euro is strong. You’re doing it because you believe that the American company’s products are good enough to withstand the test of time…

Because EVENTUALLY, the dollar will stabilize against the euro, and if an American company’s products are not competitive in Euroland…they will get deep-sixed – EVENTUALLY.

Small-cap manufacturers such as Alamo, DURA Automotive and Cascade are exploiting this exceptional opportunity in Europe. Let’s take a look…

Alamo is a leading manufacturer of tractor-mounted mowing and vegetation maintenance equipment, street sweepers, agricultural implements and related after-market parts. In its 2004 third-quarter results, the company reported that its European division saw sales skyrocket 50%, to $25.4 million, over sales of $17 million in the same period of 2003.
“Our brightest area continues to be our European division,” said the company’s CEO, Ron Robinson.

DURA Automotive, meanwhile, weighed in with third-quarter 2004 results that hit $616.4 million, up 11.2% from $554.4 in the same period the prior year. But get this…In the press release, the manufacturer of driving-control and seating-control systems said factors that favorably impacted revenue included the strengthening of European
currencies in relation to the U.S. dollar, which added revenue of $22.9 million. And as a small-cap investor, this is exactly the kind of breakout figure you need to find. Because it means that the European operation remains healthy, but $22.9 million extra revenue was posted just based on currency exchange rates.

Things are looking good for Cascade as well on the European front. In its quarterly press release announcing results for the period ending Oct. 31, 2004, Cascade noted that revenue growth in Europe for the company’s forklifts was up 20% over the same period in 2003, “excluding the effect of currency changes.” While the company did not break
out European numbers, Cascade’s quarterly net sales were $96.3 million, an increase of 27.5% over the $75.5 million posted in the third quarter of 2003. The company said it remained “cautiously optimistic” about the European market.

And you should, too…

That is, providing you’re bearish on the dollar against the euro. If so, small-cap manufacturers could face a record-breaking year in Euroland. And Rick would not have eaten frog legs in vain.

Happy investing,

Irwin Greenstein

February 08, 2005

P.S. If you want to ignore Dr. Richebacher, you do so at your own peril. As a master classical economist, his straight-shooting analysis delivers incredible returns. Richebacher is leading the charge against the lies coming out of Wall Street and Washington.

Frog Legs, Oysters and Small-Cap Manufacturing was originally featured in the Penny Sleuth.

***Mr. Market continues to struggle. Since the beginning of the year, investors have yanked almost $1.5 billion out of the Russell 2000. As a result, our benchmark small-cap index is down 6.1% from its high of 656 on Dec. 31, 2004.

So what are you to do, dear reader?

The answer is twofold…

First, if you are holding onto speculative stocks with little in the way of earnings,no cash, lots of debt and a balance sheet that would scare any decent accountant silly, you may consider getting rid of them now!

According to TrimTabs (which calculates how much money is flowing in and out of the market every day), “Yesterday was the first day in five days that speculative stocks actually rose in the last hour of trading.”

Hmmm…if you are like me, you really don’t want to hold stocks that only rise one out of
every five days!

When the market is struggling for direction, the last thing you want to be doing is holding onto highly speculative stocks. So maybe it’s time to unload them. Just a thought!

The second thing you need to remember in this market is to have patience.

***A year or so ago, I spoke at a conference in New Orleans. As you might have guessed, I spoke about small-cap stocks. I made my big presentation in the morning. And then, as is customary at these conferences, I met with the attendees for cocktails in the evening.

One of the gentlemen I spoke with, while sipping on an alcoholic beverage, was intrigued by the allure of small-cap, aka penny, stocks. So we got to talking. About 15 minutes or so into our conversation, he asked me a question I normally don’t get asked. He said, “James, what is the biggest frustration you find in your line of work?”

My answer…

“I wish I could convince people to have some patience. Anyone who has studied the small-cap market, like I have, knows there is a lot of risk involved. But the longer you are willing to hold stock in good companies, the better your returns will be – and the less risk you will assume.”

In fact, Ibbotson Associates, a research firm based in Chicago, proved my point to a tee. In a classic study comparing large-cap versus small-cap returns, they found that…

“Small stocks again are riskier than large stocks for shorter holding periods, with lower minimum ending values for holding periods of under 13 years. However, for holding periods of 19 years or more, small stocks beat large stocks over 90% of the time. And for holding periods longer than 29 years, small stocks always outperformed large stocks.”

This is HUGE stuff!

If you want to beat the market over the long run, you MUST invest in small-cap stocks. And you must have some patience.

So why don’t people learn this stuff in school? Why don’t young adults learn to invest in small-cap companies when they are investing for the future?

Because we live in a world where the brokers and major stock analysts rule – and the companies they cover, the stocks they recommend and the companies they do business with are all large caps. And we also live in a world where people want returns, and they want them NOW.

Unfortunately, this world doesn’t work like that.

In fact, Carl Waynberg, who follows the OTC Big Board and Pink Sheets markets for his GRIP readers, wrote this yesterday about risk and patience…

“Because short-term risk increases as market cap decreases, an increasing aversion to risk tends to be tougher on small- and micro-cap stocks. And that’s what we’re seeing in the action on the Russell 2000. The small-cap benchmark was showing some signs of strength against big caps a couple weeks ago, but now looks ready to cede the reins of market leadership to its bigger brother. This, too, is bearish for the broader market. Indeed, big caps tend to fare best when they are being outperformed by small caps.

“Since The GRIP is about long-term performance, let’s look a little longer term than a month. Since its inception on Aug. 31, The GRIP Portfolio is up 351%. The S&P 500, Nasdaq and Russell 2000 are up 6.5%, 11.3% and 13.1%, respectively, for the same time period. I understand most of you didn’t become GRIPPERs until the end of December, so it bears repeating that The GRIP is a long-term strategy. Some GRIP picks remains GRIP picks for two years – even longer, as you know. I trust The GRIP’s underlying principles, because I’ve been living by them for years, but you have to ask yourself if you can, too. I think you’ll find there’s empirical evidence to support that old cliche. Patience is a virtue.”

***If Carl didn’t just prove my point, I don’t know what to say. In the last month, every small-cap investor I know has taken a beating. Heck, even a few of Carl’s picks have fallen off a bit. But since Aug. 31, his entire portfolio is up 351%!

Those who have patience do better than those who don’t. Period!

By the way…

*** One more note on patience…

As I was cleaning out my e-mail inbox yesterday, I actually came across a note from that gentleman I spoke to in New Orleans. It turns out he actually took my “patience” advice to heart. Check out his note…

“Hi, James:
“As many people as you meet and deal with, I am sure you will not remember me, BUT I met you in person in New Orleans last year at that seminar. At the reception, we had a bit of conversation (after a few drinks), and one of the things you shared with me was the great opportunities in penny stocks. And that a point of frustration for you was investors wanting very quick profits. That if they would just hold for longer periods of time, they would/could make better returns. And then earlier this year you wrote about the value of holding longer.

“Well, I always want/like quick profits. But I decided to try the longer hold on penny stocks. I chose Navarre Corp. (NAVR:NASDAQ). You recommended it as a buy Nov. 25, 2003 @ $5.35. Then, in January 2004, you changed it to a hold, and finally, in May 2004, you said sell for a 27.8% profit. NOT BAD. “But I said I will try James’ hold-longer thought. I am still holding it at $16.39. A 300%-plus gain!! Just wanted to let you know how right you were and say THANKS, THANKS, THANKS.”

***Finally, here’s a nugget of information you won’t get anywhere else…While most major indexes are getting spanked right now, I have noticed one sector that the major hedge funds and institutions are throwing their money into…GOLD.Since the beginning of the year, over $1.5 billion has flowed into gold funds. I wonder if
that means they are about to take off…again?Stay tuned…

***Irwin, I believe I have said enough today. It’s time for you to wow us with your talk of Superleverage and my favorite four-letter word: risk. Take us home…

Superleverage and Sensible Speculation

Speculating on small-cap stocks is the best  thing I can think of. It’s an incredible rush – especially when you can pocket profits of 378%, 336% and 227% courtesy of options guru Steve Sarnoff. But when Steve ratchets it up by talking about how you can speculate on stocks using other people’s money (OPM), the offer is irresistible.

Steve is founder and president of Sarnoff’s Samurai Strategies, as well as editor of Options Hotline – the newsletter which has delivering gravity-defying returns for the past 15 years. Steve pioneered the use of Japanese candlestick charting techniques to accurately predict price movement of stocks and commodities. How good is he at it? If
you had invested $5,000 in each of his recommendations since 1999, you’d be sitting on a cool $1,001,810 profit.

By applying candlestick charting to shed light on stock options opportunities, he has produced breathtaking gains. How about 898% in TRW in 31 days, 209% in Micron in six days or 260% on Starbucks in five days? If this sounds too good to be true, there’s one important thing you need to understand: Steve has spent years mastering candlestick charting…and now, after staying up till the wee hours reading about it, writing about it and applying it, all that hard work is paying off – big time.

Before I continue, I know that many of you are in the dark about candlestick charting. So as your devoted Penny Sleuth, I’m going to take a minute for quick, snapshot explanation…

Candlestick charts were originally developed in Japan over 150 years ago, where traders applied it to determine the price of rice. Today, this ancient technique has been successfully employed for revealing both the price of a stock (or commodity) and market sentiment.

Think of a candlestick with a wick at the top and bottom. The length of the candlestick spans the daily open and close. The wicks show the high and low of the day. Candlesticks with a white body indicate a close that is higher than the open. Candlesticks with a black body signal that the daily close is lower than the open.

By looking at the color of the bar, you can immediately see if the market is bullish or bearish about a stock, instantly deciphering sentiment without specific references to the price. It’s a safe way to make split-second decisions.

There are variations on the candlestick that go by names of plain doji, dragonfly doji and gravestone doji. From my perspective, candlestick charting is a Zen kind of thing.And because Steve is a candlestick Zen master, he is also into the Zen of OPM for making yourself hefty profits.

I was recently given the opportunity to get in touch with Steve, and afterward, my immediate reaction was that my Penny Sleuth readers MUST know about his valuable secrets ASAP.

But first a cautionary note that comes directly from Steve himself…

“If anyone tries to sell you something that claims sky-high returns with low risk, zip your pockets. If you are going to have a chance to make high returns, you are going to face high risk. The only certainty in markets is that they’ll fluctuate. Speculators make their fortunes from those changing prices.”

And this is a basic investment philosophy of your Penny Sleuth team. There are no shortcuts to profits. That’s why we follow the investment strategies of the Wall Street legends who had proven this time and again. Warren Buffet, Phil Fischer, Benjamin Graham…and Steve Sarnoff – all of them produced fortunes for themselves and others by
adhering to common-sense investing: research, risk management and patience.

What impressed me about Steve is that he has taken it one step further. He believes that leverage is an important tool for speculators. Leverage involves using OPM to try to make more money than you can with your own funds. Those who utilize financial leverage know that using OPM may augment their rewards when right, but may also
greatly accelerate risk of additional losses when wrong. The key is that if leverage can be applied with an always known and strictly limited risk, it takes on a more sensible aspect.

That’s why Steve is an unwavering believer is something he calls Superleverage.

As Steve tells it, “Superleverage is the art of profiting from changing prices, with limited risk at all times, without ever getting a margin call, being asked for additional funds or having your position liquidated.”

The instruments of Superleverage are exchange-traded put and call options. Buyers of puts and calls are the only ones who possess the full profit power of Superleverage (unlimited profit potential with an always known and strictly limited risk).

Buying puts and buying calls may be the simplest options strategy, but Steve said that he often found the simplest way is the most effective. While more complex “spread” strategies can further limit your risk, they also limit your gain.

According to Steve, the advantages of using Superleverage are “You don’t need to be a financial wizard or have large sums of money to participate. Only as an option buyer do you have all the benefit of using OPM when right, without the concomitant costs and risks when wrong. And your total risk is always known and limited to your cost of taking
a position (making your bet).”

He also wisely counseled on the disadvantages: “The odds are against you. Options are wasting assets. And if the underlying security doesn’t move enough to give you real value before a specified date, your options will expire worthless. That is your risk.”

You’d think a guy like Steve would be sort of fearless. After all, in 2004, of his 34 option recommendations, 30 were winners.

To Steve’s own credit, he admits, “When I’m wrong (and it happens plenty enough), my subscribers can lose 100% of their speculation, but not one cent more. And that’s the important part, because when I’m right, they have an opportunity to multiply their money many times over. But there’s no easy money in markets, and regularly reaping hard-earned rewards is a worthy challenge.”

Well said, Steve. That begs the question of how can you do that?

He weighed in with a great answer…

“Develop what I call your ‘Complete Game Plan for Trading Success.’ Follow the Boy Scout mott ‘Be Prepared.’ The secret to Bill Belichick’s success, as coach of the New England Patriots football club, is his team’s thorough preparation for each game. There should be no surprises. For each trade, you should consider what action you will take if you are right (where to take profits and how much of your position to exit) and what you’ll do if wrong (use stop-loss strategies, or hold on and risk a worthless expiration).”

Steve went on to explain the three cornerstones of a complete game plan: psychology, method and money management.

“Psychology concerns your suitability to speculate. Successful speculators must possess the “Twin Tolerances for Risk.” Financial tolerance is easier to determine. Do the math…annual income, liquid net worth, etc. You should only speculate with risk capital (money you can afford to lose). Psychological tolerance requires you to be able to sleep
at night and not let roller-coaster markets adversely affect your family life. You must look deep inside yourself to determine if you have the nerve and can handle the pressure of speculation.”

He continued…

“The most important factor in successful speculation is sound money management. Trading success is more a function of honing your survival skills than picking winners. Most people have it backwards. They speculate based on hyped-up hopes of fantastic profits. You should speculate based on what you can lose, not what you can gain. Be
prepared to handle trading losses. Never add to a losing position. That is how many players get knocked out of the game. You want to be in there when the market goes your way. You, or your broker, must monitor your positions closely. They don’t ring a bell when it’s time to get out, so make sure you have an exit strategy in place for each trade.”

So now you can see why I was so excited to share Steve’s insights with you. He has mastered the art of integrating world-class candlestick charting with common-sense Wall Street investment principles. And the beauty of it is that he’s made it very easy to use.

Happy investing,

Irwin Greenstein

January 28, 2005

Superleverage and Sensible Speculation was originally featured in the Penny Sleuth.

*** It was a meeting of the minds. The editors of Outstanding Investments, The GRIP, Fleet Street, Penny Stock Fortunes, MST Trader Alert, Vantage Point Investment Advisory and Penny Sleuth were all locked in a conference room for five hours at our headquarters in Baltimore. Our mission: to share our single very best investment idea for the next month.

What an afternoon it was…

Todd McKew, editor of the MST Trader System, started things off by reading an excerpt from a magazine…

“In a little village outside Tokyo, Japan, called Yuzuri Hara, a man by the name of Hiroshi Sakamoto wakes up every morning to farm his field. Mr. Sakamoto is 86 years old and spends about four or five hours working each day. And he is not the only man in his village that old. More than 10% of his village is 85 years or older — and they are living longer and longer every year.

“In fact, not only are the people of Yuzuri Hara living longer, they are living much healthier. Many of them don’t have to see a doctor, and diseases like cancer, diabetes and Alzheimer’s are almost nonexistent in the town. Plus, their skin is smooth and young looking. There are almost no signs of aging. And that’s impressive when you consider many of the people work outside all day and don’t use much sunscreen (if any at all).

“For instance…

“Tadanao Takahashi, 93, has worked in the sun for 50 years, never once using sunblock or skin cream. The unhealthy habits don’t stop there, Sakamoto smokes a pack of cigarettes a day and doctors tell him he is in good health and is physically fit.

“Many people believe that the town of Yuzuri Hara holds the key to the ‘Fountain of Youth.’ But medical researchers believe it is their unique diet that is the key to their anti-aging enigma. Foods like satsumaimo, a type of sweet potato; satoimo, a sticky white potato; konyaku, a gelatinous root vegetable concoction; and imoji, a potato root, are just some of their favorites.”

It turns out these Japanese villagers consume a high level of hyaluronic acid — a natural substance found in our bones, joints, skin, lips and eyes that lubricates, cushions and protects our soft tissues and cells.

Not only is hyaluronic acid important for preventing and treating osteoarthritis,it is also one of the enzymes that staves off wrinkles associated with old age. So that’s exactly why the villagers in Yuzuri Hara are not only living longer bu tkeeping their youthful appearance.

That’s great, but how could that possibly help us — as investors?

Well, it turns out, Todd discovered a company that trades on the Pink Sheets called Novozymes (NVZMF:PINK SHEETS). It uses strains of this hyaluronic acid in creams and injections to help people fight advanced stages of osteoarthritis well as get rid of wrinkles. (According to Todd, the FDA has approved both applications!) And the stock is taking off…

In the last year it has jumped from $36 to $48. And Todd says the sky’s the limit for this company.

We’ll see what happens with Novozymes. But it was certainly an interesting story. Expect to hear more from Todd in the future…

*** Next up was Outstanding Investments editor Kevin Kerr — who is quoted in CBS MarketWatch on a weekly basis for his expertise in the commodities markets. Kevin shared his insights about gold, oil, natural gas and even shipping companies with us. And I have to say, he made me think — a lot.

“This may be a great opportunity to add a shipping company to your portfolio,” Kevin said from the other side of the long conference table. And his logic was pretty simple…

“As demand for oil continues to be strong, so will demand for the shipping companies that transport that oil all over the globe.”

Made perfect sense to me. So I asked Kevin what company he liked the most.

It just so happens he came prepared with an annual report and a ton of company information on OMI Corp. (OMM:NYSE) — a relatively small company based out of Stamford, Conn.

What attracted Kevin to OMI was how young the company’s fleet of ships is. He explained that most ships in the industry have a lifespan of about 20 years. And the majority of OMI’s ships are only 3-6 years old. That gives OMI a distinct advantage over its older competitors. It means the company will have to spend less money buying new ships or restoring older models. And that should matter when it comes time to report earnings and net profit margins.

Then Kevin encouraged us all to look at OMI’s price chart from last year.

So your Penny Sleuth editor did. And I was impressed…

After making a run from $10 to over $20, it recently corrected back down to under $17. And as oil prices rise back up, there’s a good chance OMI’s stock price will too.

We’ll see…

By the way, if you want another shipping company to look at, check out Excel Maritime Carriers (EXM:AMEX). It also made a huge run in 2004 — as oil prices rose. The stock rose from $4 to $65. And now it’s trading at $23. May be worth checking out!

If you are interested in learning more about Kevin and his services, check out his report on natural resources…

http://www.agora-inc.com/reports/OST/dayB03

*** Finally, your very own Penny Sleuth — Irwin Greenstein — wowed us with all the opportunities that he sees in China in 2005. Specifically, Irwin expects this to be a banner year for Chinese IPOs on the Nasdaq.

According to Irwin, “Thirty-five percent of all IPOs on the Nasdaq last year were Chinese companies. And this year will be no different.”

In fact, below, Irwin shows you two private Chinese companies that you should keep an eye on right now. He thinks they will make a lot of noise in 2005 — as they go public…soon! Check ‘em out…

By the way, Irwin and I aren’t the only ones who think investors will be able to make a lot of money in China this year. My colleague Steve Sjuggerud found a way that you could make 675% by tapping into a $474 BILLION fund backed by the Chinese government. Find out more by clicking on this report…

http://www.agora-inc.com/reports/TRW/WTRWF164

Steve is one of the smartest investors you will ever meet. So you will not go wrong checking out what he has to say.

Irwin, tell us about the two Chinese companies you think will go big when they hit the Nasdaq in 2005…

Chinese IPOs March on the Nasdaq

Put your broker on speed dial if you want to cash in on the biggest IPO phenomenon of the year. Given the tremendous demand for these foreign companies, it can only take a few hours for a great small-cap opportunity to slip through your fingers. Make no bones about it: Chinese IPOs in America will break out in 2005.

The momentum will accelerate from 2004, when 35% of the Nasdaq’s IPOs were Chinese companies — nearly all of them tech. The Chinese call it “marching on the Nasdaq.” But what it really means is that the bull and the bear will geta new rival: the dragon.

In China, as futuristic cities of glass rise up from rice paddies and an emerging middle class leapfrogs industrialized economies into the digital age, home growntech entrepreneurs are turning to the public markets to sustain intense growth and competition. While Hong Kong’s GEM stock exchange has enjoyed the boom, the Nasdaq has become the exchange of choice for Chinese entrepreneurs and their backers — affording American small-cap investors the easiest entry yet to these hot new tech issues.

The march on the Nasdaq corresponds with new Chinese legislation that makes it tougher than ever to go public on the national Shanghai and Shenzhen exchanges.

As of Jan. 1, the China Securities Regulatory Commission adopted a rigorous IPO pricing system to stop the sandbagging blamed for heavy shareholder losses. In the past, artificially low initial prices caused stocks to soar when they opened — and that’s when insiders cashed out. As the stocks dropped dead, mom and pop shareholders were left broke. This scheme had reached epidemic proportions until the government finally cracked down with a six-month ban on IPOs. The ban was lifted when the new policy took effect with the new year, dictating a broad and expert consensus for ethical price setting. Regardless, the Chinese stock exchanges still pale against the Nasdaq’s liquidity, volume — and sex appeal.
For instance…

Before China.com went public on the Nasdaq, in 1999, the computer services provider barely registered as a blip in the Chinese collective consciousness. After opening day, when its stock exploded from an initial price of $20 to a closing price of $67, the 235% surge turned China.com into an overnight sensation — jolting the popularity of its Web site in China from No. 39 to No. 6.

Although China.com’s stock price eventually tanked to under $4, its seismic IPO awakened Wall Street to the possibility of speaking Mandarin.

It also showed Chinese executives that the pot of gold at the end of the rainbow indeed had an address: 1500 Broadway, New York, N.Y.

The Nasdaq was a logical choice for Chinese companies looking to go public in the United States. The exchange lists the lion’s share of public tech companies, including 88% in the semiconductor sector, 90% of biotech and 75% in a sector called “computers and peripherals.” Given that nearly all the Nasdaq Chinese IPOs are tech ventures, it was a natural fit.

In fact, it was an excellent fit…

Small-cap investors who got in early made a killing in 2000 on two Nasdaq Chinese IPOs. After online media company SINA closed on its first day of tradingat $20.69, it has since shot up to $26.77 as of yesterday — a gain of 29.4%. And NetEase.com, a gaming and content provider, took a joy ride of 293.1% from its first-day close of $12.12 to yesterday’s closing price of $49.97.

But here’s the small-cap rub…

These companies surpassed the small-cap valuation limit of a $1 billion in no time flat. For SINA, it took less than 30 days. Netease.com had to wait almost three years to approach a $1 billion market cap, and then suddenly blew right through it to its current market cap of $1.61 billion. But the pattern was established for the Nasdaq Chinese IPO: Once the resistance level is shattered, the price keeps ongoingright out of the small-cap ballpark.

The rally continued into 2004, especially when it came to 51job, Inc. and Shanda Interactive Entertainment, Ltd.

51job is China’s Monster.com — a top job search site. 51job recently tipped out of small-cap territory, with a market cap of $1.19 billion. All you have to do is look at its stock performance to see that 51job is well on its way to a mid-cap ranking. Since the first day of trading, Sept. 30, when the stock closed at $20.75, it has increased to $45.05 today. That’s a gain of ONLY 117.1% in about3½ months. So small-cap investors who dawdled…lost out.

Same with Shanda Interactive…

It’s one of China’s biggest online gaming operators — allowing up to 1.4 million concurrent users to virtually chase, maim and kill each other just for the hell of it. When its stock appeared on the Nasdaq, in mid-May 2004, at $11.30,the company was a rising small-cap wonder. Today, Shanda Interactive has a market cap of $2.67 billion and its stock is trading at $37.60. So how long does it take for one of these stocks to jump 232.7%?

2005 will be another a blockbuster year for Chinese IPOs on the Nasdaq. And right now, the buzz is all about Target Media Holdings, Ltd. and Focus Media Holding Co., Ltd.

Although neither of these companies is public yet, their 2005 debut on the Nasdaq is widely anticipated. When that happens, expect a war between the two Chinese online media adversaries. They compete for closed-circuit TV advertising that is broadcast over wireless networks within buildings. Focus Media pegs the market size of that advertising segment in China at $20-30 billion over the next four years.

Target Media has lined up a true heavyweight backer, The Carlyle Group. The $15 million infusion from these guys buys access to the political and financial clout from powerful statesmen and financiers worldwide. To make a point, former President George H.W. Bush served as a senior advisor to The Carlyle Group.

Focus Media has in its corner investment banker Goldman Sachs — which seems to have seized the lead in shepherding Chinese tech companies onto the Nasdaq. Goldman has invested $30 million in Focus Media. And that’s on top of the$40 million from Japan’s SOFTBANK — perhaps the most influential investment and technology company in Asia. Overall, Focus Media has raised about $70 million,making for a formidable war chest in its battle against Target Media.

In addition to these two juggernauts, I’m sure there will be plenty of surprises. We’ll keep our eyes on TechFaith (wireless handsets), Junnet (prepaid cards for online games) and Watchdata Technologies (secure computer operating systems) for possible Nasdaq IPOs later this year.

So don’t miss out. Put your broker on speed dial…and check your e-mail box every Tuesday and Friday for the latest developments in Penny Sleuth.

Or face the wrath of the dragon.

Happy investing,

Irwin Greenstein

January 21, 2005

Chinese IPOs March on the Nasdaq was originally featured in the Penny Sleuth.