Here at Penny Sleuth, we sometimes lean toward the more risky investments because of the better payoff, but that’s not always the case. We like solid companies, with strong balance sheets and considerable growth. In times of market turmoil, that’s exactly what you should look for, too.

There are a few criteria that we look for to get us through tough times in the market. The first thing we have to look at is how well the company is growing. I like to use a hearty 25% revenue growth rate to make sure the company is still in the high growth stage we like.

The second thing to look for is the balance sheet. To make sure the company is in a financially healthy position, I always consider the debt-to-equity ratio. Here I want to have less than half the debt to the shareholders’ equity.

Finally, just like any investor or mutual fund, it’s sometimes smart to have a larger portion of your investment capital in cash. Regular companies are no different. If the market is acting up, it might be smart to wait for the bottom before reinvesting that capital in investments or even acquisitions. So here, I look for a cash position to be 50% of the company’s total assets.

With these three criteria we get a small-cap screen that looks like this:

I ran this screen just to see what would come up, and I wasn’t surprised. Of the 30 stocks that came up, many had done very well in the past three months, when everything else seemed to tank.

Three names stuck out to me from the list: Life Partners Holdings Inc. (LPHI: NASDAQ), AspenBio Pharma Inc. (APPY: NASDAQ), Basin Water Inc. (BWTR: NASDAQ).

I had recently seen Life Partners on a list of market performers, and sure enough in the past three months it had rocketed up 95%. Life Partners isn’t what you probably think it is. It’s a financial services and life insurance company, which I tend to shy away from because of the risks associated with it. This one specializes in life insurance policies for the terminally ill and the elderly, which can be a pretty risky play. However, this one seems to be doing just fine.

The second one, AspenBio, is a biotech company with their entire product pipeline in the development stages. Fortunately, the stock just got a boost by jumping from the Bulletin Board to the Nasdaq Capital Markets Exchange last month. This shot investors’ shares up 15% in a week.

The third company that matched our screen was one called Basin Water. It is a water treatment company in the right place at the right time. With the water concerns we have here in this country (and everywhere else in the world, for that matter), this well-water-treatment company has made its mark at just the right time, gaining 68% return over the last three months.

The point being, no matter what the market throws at us, we just have to be prepared with a backup plan. The market may take a little bit to turn around. That’s okay, though. As long as a company has a strong balance sheet and some top-line growth, it should be all right. It might even make you a buck or two.

So the next time you hear someone complaining about the stock market, you can say “No sweat… I got this one.”

Sincerely,
Jim Nelson
September 12, 2007

P.S.: Fellow Agorian Chris Mayer looks for similar things. He is the best at finding companies with superb balance sheets. Many times he finds hidden assets that aren’t valued into the company’s share price and exploits it. He does this better than anyone I know. In fact, he just gave his Capital & Crisis readers a 230% gain that he closed out yesterday.

Investing with a 7-2 Off Suit was originally featured in the Penny Sleuth.