You’ve gotta be tough to be a small-cap investor. Pansies, wusses and shortsighted people should not even consider investing in companies with market caps south of $1.5 billion.

The truth of the matter is over long periods of time, there is no better place to put your money than in small-cap stocks. Smaller companies are more nimble, innovative and adaptable than their larger peers. And while not every company will survive the Wall Street jungle, those that do can make you a lot of money.

During my career here with Penny Stock Fortunes, we’ve certainly seen a lot of tremendous gains. I remember getting in on some of the junior gold and silver companies in 2002 when they traded for less than $1…SIRIUS Satellite Radio at 67 cents…and China Yuchai at $7. The gains can certainly be spectacular.

Long-Term Small-Cap Investing: When the Market Spoils Your Best Intentions…

However, in shorter timeframes (less than three years), small-cap stocks are subject to wild and often volatile price swings. It is during these times that the shortsighted investors cash out en masse — usually for a loss. And these are exactly the same people who vow never to “invest” in small companies again. For instance…

I’ll never forget one e-mail I received from a Penny Stock Fortunes reader in October 2002. He bought shares of General Maritime (GMR:NYSE) based on a recommendation I made in the August ’02 Penny issue. At the time, GMR was dirt-cheap. It traded for about 10 times earnings, 0.7 times sales and was cash positive for nine straight quarters. Plus, it was ramping up for major growth. In the 14 months leading up to my recommendation, it added 15 new tankers to its fleet…more than doubling in size.

Based on my analysis, I said GMR was set to rise as high as $28 a share — if it were priced like other companies in the sector. I knew GMR was a fantastic candidate to make investors a lot of money. But what I didn’t know was that Mr. Market was about to throw a wrench into my plans — temporarily, at least.

Shortly after I sent out the buy recommendation for GMR, the stock fell over 50%. Following a stop loss, I was forced to sell the stock. And the next day, I got the worst e-mail I ever received.

One gentleman wrote me and said he put all of his daughter’s college money into this one pick — because I was SO bullish on its prospects. Needless to say, he lost 50% of that money in a few months. Besides telling me his daughter would not be able to go to college thanks to me, he called me more foul names than I have ever been called before — all combined.

I was so upset by what I read, I actually got sick in my office and had to wipe the tears out of my eyes. I thought about hanging it up then and there and doing something else for a living. But then I came to my senses…

None of my analysis was wrong on GMR. It was cheap. It was fundamentally sound. And it was ramping up for tremendous growth. The only problem was it didn’t all happen overnight. It took about a year for the price of oil to rise and for tanker demand to really ramp up. And in the meantime, impatient investors bailed on GMR as the price fell.

Long-Term Small-Cap Investing: Patience, Patience, Patience

As I preach here in Penny Sleuth all the time, you must be willing to hold through the bad times if you ever hope to make money in the long term. It is impossible to time the market. And GMR is a classic example of what happens if you try to (and don’t have patience).

Between July and October, GMR’s stock fell in half — from about $10 to $5. But those who had the stomach and resolve to hold on (based on the fundamental story alone) would have owned one of the best stocks on the market for the next four years.

As oil prices started to rise, GMR’s business picked up. All of its ships were being used to transport oil across the Atlantic for companies like Shell, Citgo, ExxonMobil, ChevronTexaco, Sun and Kuwait Petroleum. And its top and bottom lines rose three- and four-fold from 2002-2006.

Needless to say, its stock price followed suit.

Shares of GMR reached as high as $53 in early 2005. And despite a pullback, this one-time small-cap stock is still trading high, at $36

Investors who held onto GMR are up 260% in a 3 1/2-year span. Annualized out, that’s a nice 18% gain every year. Not too bad, considering the Russell 2000 (which has trounced the market over the last seven years) has averaged a 14% gain during that same time.

Look, not every stock is going to make you money if you hold for three years. Some will go out of business…some will flounder about…and some will just tank. That’s an inevitable risk of the business. But remember two things…

The most you can lose by investing in any small-cap stock is 100%. Meanwhile, your potential gains are unlimited. And secondly, if you aren’t willing to hold onto a good company — even when the share price falls (sometimes even significantly) — you should not be buying small-cap companies at all.

No great investor I know or have studied ever made a fortune investing with a three-month timeframe in mind. It simply isn’t possible.

Guys like Templeton, Buffett, Greenblatt and Price made their fortunes by investing in companies that were beaten down, ignored and flying under Wall Street’s radar. They didn’t panic when a stock they liked went down. They weren’t wusses. And they weren’t shortsighted.

As you take a look at your portfolio, make sure you know why you own each stock you have. If the fundamental reason you bought is strong, stick to your guns. Don’t be a wuss.

Here’s to good investing,

James Boric
February 9, 2006

P.S. That guy who put his daughter’s college fund into one stock was an idiot. You should NEVER put money you can’t afford to lose into the stock market — let alone your child’s entire college tuition. Come on! Common sense means a lot in investing!

Long-Term Small-Cap Investing: Pansies, Wusses and Shortsighted Investors, Listen Up! was originally featured in the Penny Sleuth.