*** 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.

*** While the temperature dips into the 20s here, it’s a good time to dig under the covers to find out what’s really going on with the small-cap indexes relative to their large-cap scoreboards.

For February, the blue chip S&P 500 closed the month up 1.89%, underperforming the small-cap S&P 600, which gained 2.77%. While Wall Street’s chickens in pinstripes keep crying that the small-cap sky is falling, the S&P 600 set a 52-week high yesterday by closing at 332.53 — the previous high during that period being 331.82. And chances are if it weren’t for the inflated prices of the oil and energy stocks that dominate the large-cap universe, small caps would have absolutely trounced the large-caps with style.

At least that’s the sentiment of Steve Swartley, a senior research analyst for Frank Russell Co. Swartley noted that although February was the third straight month that the large-cap Russell 1000 beat the Russell 2000 small-cap index, he did, in fact, attribute the large-cap dominance to the energy sector. Last month, the Russell 1000 delivered a modest gain of 2.2%, compared with 1.7% for the Russell 2000. As long as the United States depends on the Middle East for energy, it looks like small caps’ relative performance will seem weak. But that’s great news for us…

*** Because the Reuters Investor update that hit my inbox this morning had an extremely interesting stat buried in a section called “Sentiment Screens.” At the very bottom of the section is a heading called “Lesser-Known Stocks”…companies that are listed in the Multex database that have no discernable analyst coverage. What does this mean for small-cap aficionados?

Of the 8,746 stocks listed on the Multex, 6,692, or 30.7%, have a market cap of $1 billion or less — our definitive cutoff for small caps. So in Multex, “Lesser Known Stocks” is practically synonymous with small-caps. We’ve already written about the lack of Wall Street coverage for small-cap stocks, creating incredible opportunities for investors who want to dig deep for big profits. Anyway, since Jan. 28, 2005, “Lesser-Known Stocks” have beat the S&P 500 by 289.21%. So forget about anxiously looking up at the sky.  It’s time for heads-down trading.

*** Penny Sleuth regulars have been following our coverage of shipping company IPOs, starting with the DryShips IPO in our Feb. 4 issue (http://www.pennysleuth.com/alertholder/02.04.05). Since Dry Ships went public, on Feb. 3, its stock has soared 24.9% as of 10:47 a.m. today. Well, we have another shipping company on the IPO horizon, and yes, its name is Horizon Lines.

Kevin Kerr, editor of the Resource Trader Alert and frequent commentator on Dow Jones’ MarketWatch, has been providing us with his invaluable insights. Of course, this makes tons of sense, since these ships generally carry commodities such as steel, grain and oil — the very stuff that Kevin lives and breathes. Here’s Kevin on the Horizon Lines shipping IPO…

“Once again, we are seeing more activity heating up in the shipping sector, which is near and dear to my heart. The major $288 million initial public offering by Horizon is just the latest shipping company to set sail on the seas of profits… OK, enough of the tongue in cheek. The truth is if you added the OMI Corp. shipping shares back when I spoke to James Boric and Irwin, then you already know how hot this sector is. Well, I think Horizon is going to do well. As well as old standbys General Maritime Corp., Teekay Shipping, and, of course, OMI. Even though many of these stocks have had good runs, it is my belief that they have a lot more potential to the upside.

“Make no mistake: There is a lot of volatility in these stocks, and I expect them to bounce around. However, the long-term benefit is going to be demand, demand, demand. There is going to be no lack of demand in this sector, and there are still relatively few players. The Horizon IPO is solid evidence that this sector is hot, and will heat up even more in the coming years.

“All of this activity is being fueled by major macroeconomic trends, such as the United States’ hunger for foreign goods, especially from China. Just yesterday, for example, I was down on the New York Mercantile Exchange with some editors from Agora. As we stood near the gift shop, there were boxes full of souvenirs and bobble-head trader dolls, all marked — you guessed it — ‘Made in China.’ I predict only an increase in shipping firms carving out a niche in the IPO market in the coming months.

“I will be seeing James and Irwin again soon and will tell them about more shipping companies I like after we see more IPOs. Then, they can pass the info along to you.”

Thanks, Kevin. Folks, he’s really been on a roll. Since mid-2004, Kevin is 17 for 17 — or batting 100% on his commodity trades. Around here, we call him the Maniac Trader.

*** As your humble and diligent Penny Sleuth, I must in good conscience bring you up to date on what’s happening with Fleet Street editor Chris Mayer’s rumored trading service. Chris has finally nailed down a date for the launch of his new CrisisPoint Trader — inspired by the old Dow Theory masters. He’ll be open for business starting the week of March 14. Watch your inbox for a special offer.

For those of you who want to see Chris live, he’ll be presenting at the Daily Reckoning Live conference at Baltimore’s Harbor Court Hotel on May 4 along with James Boric of Penny Stock Fortunes (www.psfortunes.com) fame and Addison Wiggin, the editorial director of The Daily Reckoning (www.dailyreckoning.com) and author (along with Bill Bonner) of the best-seller Financial Reckoning Day. If you’re interested in attending, contact Jayla Watje at 888-799-0463 or 410-454-0413, and she can reserve you a spot. The event is free for Fleet Street subscribers.

Chris is also working on a new Special Report that will contain six new stock ideas, some of which are too small or illiquid to recommend as the featured stock in his monthly letter (and perfect for Penny Sleuth readers). The report will be available free to Fleet readers and offered to the general public with a subscription. I’ll let you know as soon as it is available.

*** Speaking of conferences, I’ll be attending the ValueRich Small Cap Investor Conference next month in Palm Beach, Fla. And noted stock commentator Jim Cramer is involved through the theory of six degrees of separation.  Read on…

The Media Mandate

Prime-time investing guru Jim Cramer would have loved what happened when the CEO of a small-cap tech company called me…

At the time, I had been in PR, and the CEO was my client. He was on a breathtaking acquisition binge, and Wall Street was extremely skeptical of his latest buyout. In fact, the analysts reviled it so much that the stock tanked 15% — just when a lockup period was ending for insiders to unload. Millions of dollars were at stake, and the CEO needed my help…again.

That’s because I had already booked him on popular financial TV shows, and after each appearance, the stock spiked…before retreating to its latest resistance level. This time, though, he really wanted to goose up the price in anticipation of an analyst presentation — trying to generate Wall Street coverage that the deal had legs. Could I possibly perform another PR miracle?

I pitched my heart out to a reporter at Reuters. It took several interviews with the CEO before a glowing story crossed the wires — producing the desired effect on the stock price. And it was just those dynamics between media exposure and a media-savvy small-cap CEO that Cramer highlighted in a recent magazine interview.

For those of you who aren’t quite familiar with Cramer, he was one half of the Kudlow & Cramer (now Kudlow & Company) business and news TV show on CNBC. He made his own news when he co-founded one of the original dot-com stars, TheStreet.com. Whether on TV, the Internet or his radio show, RealMoney, Cramer has shown a penchant for small-cap companies — and for attracting controversy about his hedge fund, manic tirades and alleged stock pumping.

So given his celebrity and small-cap draw, it made perfect sense that Cramer would be invited to keynote the ValueRich Small-Cap Financial Expo in Palm Beach, Fla., March 9-12. In this playground for the rich and beautiful, there are going to be 250 small-cap executives performing their best songs and dances before thousands of venture capitalists, institutional investors and analysts — everyone chasing big ideas, big bucks and other big things. (Check out my coverage in upcoming issues of Penny Sleuth.)

Personally, I was looking forward to seeing Cramer in action, as I scoped out the formal presentations, industry gossip and fine print in search of the best stories coming out of the Palm Beach County Convention Center. But just as he was about to accept ValueRich’s offer, CNBC gave him a new live daily show. That meant, instead of talking into a microphone before an auditorium full of fans, Cramer agreed to talk into a tape recorder…the result a great four-page interview with ValueRich magazine.

In the interview segments that focused on small-cap stocks, Cramer was emphatic about the importance of PR as a competitive edge. Having been in the PR trenches, I understood what he meant when he advised that a small-company CEO should have a publicist. Why?

Because it’s vital that small-cap CEOs exploit every venue to tell their stories, according to Cramer. And as he astutely observed, there just aren’t as many media outlets for small-cap companies as there used to be during the dot-com feeding frenzy, when any geek with a Razor scooter could find his face plastered in a cheery article. So to overcome the higher barrier to entry these days, a PR pro can be a valuable asset to the company and its investors.

In the interview, Cramer likes to distinguish between small-cap companies that need cash and those that need ink (meaning media coverage). While many small-cap companies that get cash shouldn’t, there are also a lot of excellent small-cap companies that are shunned by the media. And that, he says, is where you, as an investor, have to dig deep to find them.

With the traditional media still stinging from the dot-com explosion that left an abundance of egg on their faces, it’s been years seen we’ve seen John Markoff write about a hot tech startup on Page One of The New York Times. On the other hand, over the past few years, screening software, broadband and search engines have filled the breach for small-cap Sleuthers in quiet pursuit of big profits.

The Penny Sleuth team has always advocated due diligence as integral to a successful investment strategy. When I’m looking into a company, one of the first places I hit on its Web site is the “news” section. Here’s why…

Press releases are a great way to find out how frequently a company introduces new products…and creates new revenue opportunities. In addition to the press releases, see if the company has posted related news coverage. In effect, published articles accomplish a few things: They give the company and its product credibility, raise visibility for potential customers and help convey a sense of industry leadership.

When I see a company that hasn’t issued a press release in several months, that’s a signal for me to move on. It means that ingenuity, marketing and visibility are languishing…along with investors’ money.

I also find that media coverage can provide insights into a company’s executives. If a CEO says something stupid that shows up in print, chances are he’s doing the same thing with Wall Street analysts — undermining the success of the company and its investors.

Take my word for it: I’ve been to plenty of conferences like the one in Palm Beach, and executive showmanship can make a huge difference between the success or failure of a small-cap company. And it certainly is one of my criteria in passing along the best investment opportunities to you from my front-row seat.

Stay tuned…

Happy investing,
Irwin Greenstein

March 04, 2005

The Media Mandate was originally featured in the Penny Sleuth.