*** BEWARE!

As we approach the end of the year, our friendly investment bankers, venture capitalists and entrepreneurs are flooding the IPO pipeline — to the extent that this week is expected to see the most new issues since August 2000. The IPO pipeline leads directly into the most popular small-cap indexes, such as the Russell 2000, the Nasdaq and the S&P 600.

Because all we have to do is look back to the third quarter of 2004 to see what’s in store for a very active December. Last quarter, nearly 46% of IPOs were priced below expectations, according to Reuters, and the number of withdrawn or postponed deals reached its highest quarterly total in about four years. Ouch.

So please exercise caution before buying into the frenzy. It already looks like the new issues market is overheated for 2004. This year will be a record-breaker, with 176 IPOs raising a total of $10.4 billion, Deloitte Touche reported. If everything remains on track, the number of IPOs in 2004 will be up 73% from last year. Worse, December will reach manic levels, with an unprecedented 40 new issues — flooding the market with IPOs that,
given the volume, are highly subject to stumbling big time out of the gate.

In the spirit of Christmas stories, it’s just these kinds of numbers that evoke the ghost of legendary investor Benjamin Graham. He made his millions by avoiding IPO feeding frenzies. He would rather wait it out until a company’s stock price retreated to its true market value…which was often a fraction of its debut price.

So this holiday party season, as you chitchat with friends and business associates who are trying to impress with some claptrap like, “It’s 1999 all over again,” take comfort in the knowledge that the biggest blowhards may indeed end up with a lump of IPO coal in their Christmas stockings.

*** As a Silicon Valley veteran, I know the value of innovation. Fortunes are made and lost overnight on incredible ideas — some of which are only now coming to fruition, such as e-commerce, streaming media and GPS.

That’s what I was discussing with contrarian Carl (the GRIPPER) Waynberg at Agora’s holiday party last Friday night at the historic Belvedere Hotel in Baltimore. While everyone else was eating, drinking and dancing in the luxurious 12th floor ballroom, Carl and I found ourselves off in a corner, engaged in a deep conversation about the incredible breakthroughs coming to market from microcap companies that are traded on the OTC Bulletin Board exchange.

Just so you know, the OTCBB is for tiny companies that for reasons such as capitalization, cash or share price can’t qualify for the bigger Nasdaq exchange. But once they “jump” from OTCBB to Nasdaq, the gains can be astounding. And many of these companies are bringing to market the kinds of products that revolutionize an industry…easily justifying their explosive profitability for investors. A stickler for details, Carl pointed out that 15 of the 45 recommendations he made in 2003 have graduated to Nasdaq, including chipmaker ZiLOG, which delivered a one-year gain of 280%. Not too shabby.

So how can you get a piece of this action?

Carl’s trading service — the GRIP — is launching to the public on Dec. 24. Word on the street is it will be a very exclusive service – open only to 3,000 investors. And no one without an invitation will be allowed to join. That’s the bad news.

The good news is…

Because you are a loyal Penny Sleuth reader, you will be one of the elite few who receive an invitation to become a GRIP member. Look in your e-mail inbox on Christmas Eve for a note from Addison Wiggin — Agora Financial’s publisher.

Not only will you receive an invitation to join Carl in his hunt for profitable OTCBB stocks, you will also receive a charter member discount — good for up to 80% the sticker price.

Make sure to check your e-mail on Christmas Eve. This offer expires on Jan. 1, 2005! If you miss this invitation, chances are you will not be allowed to join the GRIP.

Go get ‘em, Carl.

Ralph Wanger and His Acorns

So how does an investor begin to sift through the thousands of small-cap companies that dot the investment landscape like countless wild flowers?

One idea is to work out investment themes to help narrow the search. Ralph Wanger is one proponent of this sort of top-down screening.

For years, Wanger was the brains behind the Acorn Fund, which specialized in small companies, which he called the acorns of the investment world. Wanger forged a stellar record over 30 years, making long-term shareholders of his fund rich. Recently, his fund merged with another group and is now part of Columbia Wanger Asset Management. Today, Columbia Wanger is still built on principles hashed out by Wanger decades ago.

In Wanger’s book on small-cap investing, A Zebra in Lion Country, he discusses the idea of picking big investment themes that play out over several years and investing according to those themes.

He tells the story of Arthur Rubenstein, the late, great pianist, who was once asked to be a judge for a competition held in London. Told to use a scale of 1-20, Rubenstein gave all the students’ recitals either a zero or a 20. There were no intermediate scores. When asked about this, Rubenstein replied, “Either they can play the piano, or they cannot.”

Wanger invokes the “Rubenstein Rule” as important to his own investment philosophy. As he says, “Rather than build a broadly diversified stock portfolio, I believe in determining themes…and then identifying groups of stocks that reflect those themes.” Wanger may own a considerable number of stocks at any one time, but they all revolve around a handful of investment themes. “The Rubenstein Rule dictates that either a stock group is worth playing or it is not worth considering at all.”

In thinking about investment themes in today’s market, there are several that stand out as potentially lucrative for investors.

Perhaps the most obvious is the aging demographic profile of the industrialized world. People are living longer and healthier lives, a fact the Financial Times recently called the “most transforming element of the world we live in.”

Most of the political discussions around this reality have focused on the costs — not only for pensions and Social Security, but also in terms of medical care. The first investment opportunities that may come to mind are probably in the area of health. But investing in these areas can be tricky. The political and legal environment for drug companies is not likely to be favorable. Plus, the hit-or-miss nature of discovering new drugs and the ever-greater expenses involved are creating an industry whose basic economics may be in decline.

I believe there could be more lucrative ways of taking advantage of the fact that people are living longer healthier lives.

“Those aged 50-plus have greater amounts of disposable income and more time to spend it,” says Ladan Manteghi, director of international affairs at AARP. What are they spending it on? For one thing, they are increasingly pursuing leisure activities. I’m not talking about bingo night or watching the grandkids, either. Today’s retirees are likely to be travelers — exploring Rome or Paris, or roaming around America’s wide open spaces, enjoying good food and drink along the way. Hotels and resorts that cater to vacationing retirees are likely to enjoy a strong business environment for years to come.

Let’s look at one other theme. Consider the rapidly expanding Chinese middle class. As China grows and expands, so too will its people have more money and time to spend on the better things in life. As they progress beyond subsistence levels, as their margin for error gets a little thicker, they will want and demand things previously beyond their reach.

China’s emergence will impact global spending and investing patterns in numerous ways, affecting nearly everything — leisure, commodities, financial services and more.

These two themes — aging demographics and the emergence of China — are just two examples out of many other possible long-term investment themes around which profitable portfolios could be built. In my own newsletter, Fleet Street Letter, I’ve positioned several of our picks around long-term investment themes.

That doesn’t mean I don’t do my homework on the individual companies involved. Themes are nice to have, but you can still pay too much for your stocks or buy lousy businesses. But a wonderful business, acquired at a cheap price and helped along with a powerful investment theme, is like having a powerboat going downriver. It will make getting where you want to go a lot easier.

Regards,

Chris Mayer
Editor, Fleet Street Letter

December 21, 2004

Ralph Wanger and His Acorns was originally featured in the Penny Sleuth.