Just take a look at what the market here in the U.S. has been up to YTD:

As you can see the Dow Jones Industrial Average (black) is down double digits, followed closely by the NASDAQ Composite (blue) and the S&P 500 (gold). But those represent mostly large companies. What about the small companies?

Well they aren’t faring as bad, but still not good:

Above is the Russell 2000 Index, which is the best indicator we have for how small-cap stocks perform. That decline represents about a 2.5% loss on the year.

Pretty unsatisfying, huh?

But, I knew there has to be someone doing better… So, I quickly ran a screen to see who they are…

Using a quick small-cap mutual fund screen, I stumbled upon a few. First up is Integrity Small-Cap Growth Fund (ICPAX: NASDAQ). So far in 2008, the crew over at Integrity have been able to manage a return of more than 7%, which is quite a praiseworthy accomplishment in this market.

Integrity isn’t doing anything too special. The majority of its holdings are in “business services,” “hardware,” and “healthcare” — all of which have been beaten up this year. They are simply picking great companies like Energy Conversion Devices, Inc. (ENER: NASDAQ), which is up 141% so far this year.

That’s what I like to see in a fund…a portfolio manager that simply picks great small companies to invest in. In fact, the guy in charge of this fund, Robert Loest, was the mastermind behind the 120% return IPS Millennium Fund posted back in 1999.

I’m not saying you should go out and invest in this fund. The fund itself is very risky. With its size (about $2 million worth of assets), and no cash allocated for future investment, it’s not in the best position to take advantage of a great investment if one comes along.

The second fund that caught my eye was the Transamerica Premier Institutional Small-Cap Value Fund (TPSMX). I know, it’s a mouthful…but it’s also up 7% this year. So let’s take a look…

The first thing that caught my eye was its concentration. This is also another equities-only fund. About 36% of all its investments are in the “business services” field. But what really gets me about this fund is its next two concentrations…

About 20% of its assets are in “financial services” and another 20% are in energy stocks. In my eyes, those two cancel each other out. The “financial services” sector is not the place I’d be putting my money. Just look at Bear Stearns, Lehman Brothers, Citigroup… The list goes on and on… Energy, however, is a great place to be. Stocks in that sector are up an average of 6% with many upward of triple digits.

Unfortunately, the average investor can’t put his money in Transamerica. At least not this fund. It’s for institutional investors only. But it still gives us an idea of what the lucky few are buying.

While neither of these funds are household names, sometimes that’s the place to be. We always keep our eyes on what these hidden funds are buying, and so should you. It might just lead to the next great find…

Sincerely,

Jim Nelson
June 25, 2008

P.S.: Readers of Penny Stock Fortunes have done even better than these funds. So far this year, we are up an average of 14.3% on every position we told readers to buy. And we don’t see that slowing down anytime soon.

What the Hidden Mutual Funds Are Buying was originally featured in the Penny Sleuth.

It’s alarming… It hits you in your very core. One would think such a tremendous downturn in a single day was reserved for movies like Wall Street and Trading Places…images of brokers in white jackets screaming “Sell! Sell! Sell!”…flashing fingers, scribbling numbers on little white pads in a desperate attempt to clear their clients’ positions.

But let me assure you, this is the type of action you can expect to experience once in a very great while in the world of small-cap pharma and biotech stocks.

This industry lives and dies on FDA approvals… There’s no getting around it. Even when you believe the odds of obtaining the FDA’s green light are greater than the probability that the leaves on the trees will bloom come spring, you’re still never 100% sure… Anything can happen. It’s a world of tempered expectations.

Sometimes then highly unlikely happens. And when it does, your investment takes a dramatic turn for the worse. That’s what happened in the Small-Cap Insider portfolio yesterday with one of our holdings, NeoPharm (NEOL: NASDAQ).

But let me start from the beginning…

This past October, we found a very speculative drug company whose insiders were simply snapping up its stock. It had a drug in Phase III trials and, if successful, the stock would either rocket or fall virtually to zero. It was like an option, in a way, and not priced too much more than one.

It was a very “binary” investment opportunity — the company would win or lose, and our fortunes would ride in lock step.

We made the necessary checks, made the appropriate calls to our pharma experts in the field, and we felt comfortable in making a speculative recommendation on this company’s shares. We felt the term “speculation” was appropriate label for this idea — and we made it clear to our readers. After all, for every successful company in the drug world, there is a sea of failures.

But things seemed favorable about this company…

NeoPharm had its lead drug, cintredekin besudotox (CB), in Phase III clinical trials. Their drug was intended to prolong the lives of adults who suffer from particularly aggressive brain tumors.

NeoPharm appeared to be near a breakthrough in a better treatment than the current standard of care, the Gliadel Wafer.

Early on, results looked promising: Patients treated with NeoPharm’s CB lived for an average of 55.6 weeks versus 28 weeks with standard treatments. Because of these early positive results, CB earned orphan drug status in Europe. The FDA fast-tracked it.

And the company’s insiders seemed equally optimistic about NEOL stock.

When we wrote our initial report, company insiders had snapped up over 300,000 NEOL shares at prices ranging from $4.86 to $10.20. The company’s CEO, CFO and chairman of the board were very active buyers.

But the bottom fell out on the morning of December 11.

NeoPharm’s drug didn’t meet the benchmark level of performance, and you know the rest.

We knew the risks, and we made them abundantly clear…

We wrote: “Action to take: If you are a speculator who understands the risks, buy shares of NeoPharm, Inc. (NEOL:NASDAQ) for $7.35 or less. Use a limit order. And only invest money you can afford to lose.”

But I’m not writing this Sleuth as a defense of our recommendation. I want to highlight the fact that — yes — small-caps can be risky. They are more risky by their very nature than large-caps because they are typically younger companies in an earlier phase of their growth cycle. And that phase sometimes means that they’re vulnerable. They might not have other products to fall back on if one fails, or they don’t have the financial flexibility to dig themselves out of trouble.

That said, early-stage pharmaceutical and biotech companies are even more risky than your average small-cap.

In fact, the same day NeoPharm reported its Phase III results, Nuvelo, a development partner of Bayer Healthcare, plummeted 79% in its own failed Phase III trial.

But over time, and using a portfolio approach, small-caps can bring great rewards to investors.

If we look back to the 1920s, small-cap stocks have gained, on average, nearly 13% per year versus 10% for large-cap, “blue chip” stocks. Over many 10-year periods, small-caps have beaten large-caps by as much as 50 to 60 percentage points.

Of course, the risk of small-caps explains, in part, why their returns are superior. With greater risk come greater expected returns.

But if we look back again over the last century, we see that small-caps really shine over large-caps when the U.S. economy is growing. And for the majority of the last 80 years, the U.S. economy has been growing. There was only about a decade-and-a-half from 1926 to the present day when we were officially in recession.

So, loyal readers, the events of this week will not test our resolve.

Until next time,

Craig Walters
December 14, 2006

Pros and Cons of Small-Cap Investing was originally featured in the Penny Sleuth.

Publisher’s Note:Today’s Sleuth is brought to you by the newest member of the Sleuth team – Greg “Gunner” Guenthner. Gunner is an eager 25-year-old journalist with a passion for investing. When I found out he was a fan of Wanger, Greenblatt, Templeton, Graham, Fisher, Buffett and T. Rowe Price, I convinced him to quit his job with a local newspaper (where he covered the political scene) and write for Sleuth.

In his inaugural letter, Gunner examines the bandwagon theory, explains why discipline is crucial as a small-cap investor and unveils five unheard-of companies you should put on your watch list immediately.

Enjoy.

James

Hello Sleuths,

It’s the time of year when almost everyone is promising (whether to themselves or to loved ones) to save more money, finish painting the guestroom or — if you play on the bandwagon — shed some pounds and get in shape.

I know I’m a little late to the party. By now, you’re thinking that some slightly less resolute novice has probably fallen off his new treadmill, never to climb on again. I just love the February classifieds. For sale: treadmill and weight bench, excellent condition, red bow still attached, make offer.

Hopefully, this won’t be me. No, I didn’t get a new treadmill for Christmas, but I did promise myself to be in better shape by this time next year. It’s not that I have a weight problem — quite the opposite, actually. My motivation comes from memories of high school and college, when I seemed to have the energy to play pickup games in the gym for hours and not even get tired.

As with most things in my life, I see some important lessons that can be learned from this about investing. First (and I think most important) is that when you make a resolution, keep it. Not necessarily because it’s the right thing to do, but because no one else seems to be doing it.

Think of your portfolio as if it were a gym membership. A lot of people are buying yearlong gym memberships this month. Some people spend hundreds of dollars on initiation fees, and then agree to a contract for 12 months. For arguments sake, let’s say the initiation fee for Trendy Gym is $350, and the monthly membership fee is $75. That’s $1,250 for a year at the gym! And you quit going after March? Are you serious?!?

But wait…Let’s check out the Get Real Gym. I know I want to get in shape this year, but I’m willing to wait until the summer, when most people are on vacation and too busy to hit the gym. Initiation fees are waived, because business is slow, and at my gym, the monthly membership fee is $30. That’s a steal at $360 a year. And when I resolve to go three times a week for a year, and keep that resolution, I have the added satisfaction of getting my  money’s worth and doing something good for myself well into 2007.

Investing Resolutions: Stay off the Radar

You see where I’m going with this? Let’s dupe the average investor by buying when he’s selling, and then selling to him when he and his bandwagon brothers are feverishly buying again. And let’s do this all while staying off Wall Street’s radar in our small-cap universe. More on this in a sec…

As for my fitness revolution…err, resolution, that is:

The best way to recapture my youthful stamina, I’ve rationalized, is to start running again. In high school, I was on the track team, running 5-10 miles a day, five days a week, almost year-round. Looking back, I’d say I was in the best shape of my life back then.

It is encouraging to read the old standby New Year’s stories in the papers. The Boston Herald writes that 12.4% of all new gym memberships are added in January, more than in any other month of the year. I mentioned this to some gym rats I know, and almost all of them complained. It seems that it’s impossible to get on the equipment for the first couple of months of the new year. But after the initial surge in interest, the gym returns to normal, they said, and the “regulars” can come back out of the woodwork.

Addictions are also the target of resolutions, as I’m sure you’ve seen. This one’s from Floridatoday.com: “Anti-smoking products tend to do well in January, said Lori Lukas, a spokeswoman for GlaxoSmithKline, Inc., maker of the popular over-the-counter anti-smoking aids Nicorette, NicoDerm and Commit.”

And of course, all of these articles are filled with the common man lamenting past New Year’s resolution transgressions, followed by the promise to stay between the lines this year.

But I think we all know what will happen. The news reporter does, too — which is probably why we don’t see many follow-up pieces in March or April about the success stories. Those making resolutions fell off track, treating the resolution as a fad instead of a true and permanent change in their lives…

Investing Resolutions: Bandwagon Theory

Which brings us to our second lesson, which pertains to Bandwagon Theory. I have derived this from Newton’s High School Popularity Maxim, which postulates that if you were to lock five or more teenagers in a room together, a complete social hierarchy would be developed in less than an hour, complete with geeks, preps and jocks.

The same is true in the stock market. The bandwagon theory states that investors travel in packs, these packs are emotional and these packs create a hierarchy of stocks — some that are popular and some that aren’t.

And those who drive the bandwagon will tell you it’s the only way to go. But since you’re reading this letter, I know you don’t believe them. Neither do I. Like the value-master Joel Greenblatt says, why spend all your time and energy picking random stocks that are popular this year only to find that when you do sweat out a profit, it usually is only about what you’d get if you bought T-bills?

The wagoneers also will tell you that you CAN’T find bargains among quality stocks. They’re cheap for a reason, they’ll say. Sure, there may be some great high-yield, small-cap stocks out there, but it’s just too risky to be worth the effort.

But you and I know that’s not true, either. If we took out a dartboard that had 100 random small-cap stocks listed on it and threw 20 darts at it, buying these lucky stocks, we probably would lose money. But if we took 100 stocks that met our specific criteria (like Greenblatt does) and threw our 20  darts again, the gains we could see would be limitless.

Investing Resolutions: Sleuth Resolutions

I know I’m going with the crowd as I attempt to get in shape in 2006, so I think we should make some solid Sleuth resolutions that go a little against the grain — and stick to them, no matter what our “friends” on the bandwagon have to say about it. If we make these promises to ourselves, we should be running like the wind for years to come.

Say them with me if you want:

First, I resolve to be steadfast in my investing, sticking to my guns when the numbers say so and selling when the reasons I purchased the stock in the first place are no longer true, regardless of what the crowd is doing. When I write my investing road map, and define my criteria, I will adhere to my rules this year and in years to come and reap my rewards. An investor with a plan is an investor to be reckoned with.

Second, I will make educated decisions about my investments. Value is not the monster under my bed. There are very real excellent deals out there in Pennyland to be had, and I will find them, no matter what the wagoneers are saying (see above resolution).

You can screen ‘em with the best of us, too. Just looking for high return on equity (a company’s return on shareholders’ money) and lower-than-industry average price-to-earnings ratios can churn up some promising small caps. These criteria show us A) how effectively the company spends shareholders’ money and B) how much we’re paying for a company’s earning power.

Just check out the ones listed below (all are less than $15):

Core Molding Technologies (CMT:AMEX)
China Energy Savings Technology (CESV:NASDAQ)
United Online (UNTD:NASDAQ)
Mesa Air Group (MESA:NASDAQ)
iMergent (IIG:AMEX)

So stay tuned this year. These are the kind of small-cap value picks you’ll find every week in the Sleuth. Also, be sure to stay tuned to Penny Stock Fortunes to build your own million-dollar portfolio just by investing in undervalued companies that spend money wisely.

Oh, I’ll keep running, too. And I’ll keep my ear to the ground and let you know what’s new out there.

Until then,

Gunner
January 2, 2006

Investing Resolutions: A Sleuth’s Resolution was originally featured in the Penny Sleuth.

*** Happy Holidays to everyone. I certainly hope you are enjoying family, friends, some adult beverages and fantastic food. I am.

In the spirit of the holiday season, I will keep my notes short today. After all, the market is closed. And we have food to eat! But I do have two interesting nuggets to share with you…

First, I hope you received your exclusive membership to join Carl Waynberg’s GRIP service. The GRIP is a screening tool that tracks “jumper stocks” — the most explosive small-cap stocks in the world. These are the tiny companies that trade on the forgotten OTC BB and pick sheets exchanges that eventually “JUMP” to the NASDAQ, AMEX or NYSE — and make investors obscene amounts of dough in the process.

If you haven’t read your GRIP report, please check your e-mail inbox now. It is
important to sign up BEFORE Jan. 1!

That email is so valuable, that I’m including a special link to the information…
http://www.agora-inc.com/reports/GRP/WGRPEC16.

If you sign up before the New Year, you will save 80% off the sticker price. This is the best deal you will ever see! You can be certain the price will rise quickly come 1/1/2005. Please take advantage of this offer while it lasts.

*** Speaking of 2005, check out Irwin’s essay on due diligence. It’s an incredible story about his run-in with the legendary Larry Ellison of Oracle (who just made headlines again after winning his 18-month battle to acquire PeopleSoft). As Irwin mentions, it’s just the kind of story that New Year’s resolutions are made of. Irwin, put the pedal to the metal…

The Difference Between Making a Profit and Killing

It was Monday afternoon, April 20, 1987, and I raced my V8 Mustang against the clock on a winding road. I was running late for an interview with one of Silicon Valley’s most notorious and controversial warriors — Larry Ellison, the founder and CEO of Oracle Systems. But my meeting with Ellison wasn’t for a job interview. At the time I had been a journalist — and I was absolutely determined to walk away with a blockbuster story.

Back then, before Oracle built it’s three enormous towers, the company had a tiny facility on a cul-de-sac… accessible through a steep, narrow road lined with eucalyptus trees.  When I arrived, his secretary showed me into his office. It was small, but had an expansive feeling. In an alcove over his right shoulder, a large Buddha offered a serene smile… quite contrary to the expression that Ellison had greeted me with.

I sat down across his desk and tried to warm him up with chitchat. He wasn’t interested.  So I delved right into the questions that I had written for myself in advance. His answers were either single-word comebacks or long-winded exhortations to hype a product — and time was running out on my interview.

Finally, it dawned on me how to crack Ellison. I started talking about how great his most fierce rival was. I could resort to this because I was thoroughly prepared going into the interview. You have to be when you’re climbing into the ring with a tough nut like Ellison.

And my preparation paid off… big time.

In a classic case of one-upmanship, he started bragging about the next-generation database that Oracle was about to introduce.

Forty minutes later, I left his office with a page-one scoop.

So what does my story about Larry Ellison have to do with small-cap investing?

Today, many small-cap investors will find themselves in a situation similar to the one I found myself in trying to extract meaningful information from Larry Ellison. Why is that?

Because expert information on small-cap opportunities is becoming increasingly difficult to obtain. And that often leaves only one person to dig it up… you.

But what do you really need to know, and even more important, how do you get it? This process is called due diligence. It is the most important aspect of successful investing, especially in fast-moving small-cap stocks.

Wall Street legends such as Warren Buffett, John Templeton and T. Rowe Price sometimes spend years conducting due diligence on a company or an emerging market before investing a single penny.  And you could do worse than follow their examples.  After all, these billionaires got their start with small-cap stocks.

So the burden falls on you to find the best quality intelligence on a company… before you invest.

For many would-be small-cap investors, due diligence often involves spending hours on the Internet. The problem with that is you’ll never find the critical qualitative information — the insider opinions that can often make the difference between a profit and a killing.

I’m suggesting a bold alternative. It involves that thing on your desk with the keypad and the handset, which produces a dial tone when you pick it up.

Reporters generally get their most valuable information from phone interviews. But since you don’t have the credentials of the New York Times or The Wall Street Journal, how do you break through to a company?

Before I give you some important tips about that, there’s one thing that you have to bear in mind.  As either a shareholder or potential investor, you have an inalienable right to get the best possible information from a company. That’s the primary job of investor-relations professionals. You can find their phone numbers on the company’s Web site.

That said, you also have to conduct yourself like a professional investor. You have to treat investor-relations folks with respect and courtesy, and not waste a lot of their time… just like a reporter does.

Based on my experience as journalist, here are some simple rules you can follow to get the information you need… and put you on the path to a moneymaking, small-cap investment.

Set up your phone call appointment in advance… and be punctual at the time of the call.  If you’re in a different time zone, make sure that you establish whether it’s eastern, central or Pacific time. E-mail can be a great tool for this initial contact.

Before your scheduled phone call takes place, be PREPARED. Preparation shows that you are a knowledgeable investor… just the kind of person that a company wants support from.

The best way to be prepared is to make a list of questions. Ideally, this list should take no more than 20 minutes to go through. You should ask about things that aren’t typically found in an annual report, such as:

* Management’s philosophy toward its employees and customers
* The life expectancy of a main product line
* Sudden changes in the marketplace that could either increase or reduce risk
* Emerging industry trends that could impact the company
* New formidable competitors on the horizon
* Employee turn-over (are the rats abandoning a sinking ship?)
* Local economic-development that could bring new employee talent into the region
* The company’s plans for domestic or international expansion.

A phone call is also a wonderful opportunity to ask about things you may not understand.
This could include:

* Arcane footnotes in an annual report
* Odd items in a financial statement such as asset write-downs or goodwill
* If there’s an unusually high volume of insider selling, why is that?
* The percentage of revenues derived from the single, largest customer (you don’t want
to invest in a company that relies on a single customer for most of its income)
* Is there a high level of returns on a new product?

As you go through your list of questions, don’t be long-winded. You’ll get great results by being polite, professional and to the point.

In fact, it’s those three qualities that helped me break through to Ellison. By being polite, I demonstrated a clear sense of respect. It was my professional demeanor that led him to trust me enough so that he knew I wouldn’t screw up this very valuable piece of information he was giving me.  And by getting to the point, I never wore on his patience.

So if you’re in the habit of making New Year’s resolutions, you may want to ponder one about using the phone to dial for small-cap dollars.

Happy investing,

Irwin Greenstein

December 24, 2004

The Difference Between Making a Profit and a Killing was originally featured in the Penny Sleuth.

*** What a rally! Ever since good old George “Dubya” was elected to his second term as president, the markets have been on steroids. The Dow Jones is up 2.6% in the last couple of trading sessions. The Nasdaq is up almost 1.5%. And the often-forgotten Russell 2000 is up 2% as well. But the million-dollar question on everyone’s mind is…

How long will the rally last? And for small-cap investors, are we near the top of what could be a nasty bubble? Those are the questions both Irwin and I ponder in today’s Sleuth.

*** I reported on Tuesday that small-cap stocks are set to outpace their large-cap peers for a fifth straight year. Over that time frame, the Russell 2000 has averaged a 7.41% return for small-cap investors, compared to an annual loss of 1.3% for large-cap investors who dumped their money into the S&P 500.

So isn’t it about time for the small-cap rally to end? Let’s weigh the evidence…

Dating back to 1932, there have been six extended periods in which small-cap stocks have dominated the mighty large-caps. And it turns out the average period was 5.7 years. If you only believe in the law of averages, it seems we may be approaching the end of this recent run-up. But as your Penny Sleuth editor, I don’t rely on just one set of numbers. I like to look at the big picture.

Matthew Patsky, with Winslow Management Co., reported this past week on Forbes.com that the six small-cap runs have lasted anywhere between 3.3 years and 8.5 years.

Let’s see…8½ minus 5 is 3½. (Yes, your faithful small-cap sleuth tore up first-grade math).

Will this rally last for another 3½  years? I don’t know, dear reader. All I can do is look at the facts. And right now, small-cap stocks are still cheap compared to their larger counterparts.

*** Satya Pradhuman, a small-cap expert at Merrill Lynch, recently reported that small-cap stocks are trading for a 36% discount to large-cap stocks based on a revenue multiple. He went on to say, “In the extremes, this group has bottomed at roughly a 60% discount and peaked at almost parity. Note, current levels are roughly in line with the bottom reached in 1990, the start of the last small-cap bull market.”

As long as small-cap stocks are cheaper than anything else on the market, I expect the rally will continue. But that isn’t to say you shouldn’t be careful.

Because small-cap stocks have been generating such rich profits for so long, more and more people are getting greedy – especially people with money in their pockets. As Irwin points out below, venture capitalists raised $5.54 billion in the third quarter. That’s up 78% from the second quarter. And guess what? Irwin also found that up to 60% of the highest-risk IPOs this year have so far lost investors money. In other words…

Now is not the time to speculate in companies with no real business model, no cash and no growth. My guess is a lot of small-cap companies will come to market in the next 12 months – and most won’t be worth the ink I am using to write today’s Sleuth.

As a small-cap investor, its more important than ever to keep investing in what works – companies with growing top and bottom lines, fair multiples and a unique product line. If you are disciplined enough to stick to your guns, I can easily see fundamentally sound small-cap stocks leading the way for another three years – or more.

Only time will tell.

Until then, I have to leave my desk for a few minutes. My colleague Greg brings his pit bull puppy, Ajax, into the office every morning. Ajax perches himself on the chair next to my desk and stares at me until give him food. Luckily for him, I just gave him half of my muffin. Unfortunately for me, Ajax must have gas. Crikey! I gotta go.

All yours, Irwin…

How Not to Lose $650 Million

A new generation of small-cap companies is getting ready to invade Wall Street…and they absolutely scare the devil out of me. So I want to warn you right now: Anyone who invests in them could lose as much as $650 million – just like the last time these companies rocked the exchanges.

What are these money-losing monsters?

They are the overhyped, overvalued and overfunded companies that went bust in 2000. You know the ones I’m talking about – the dot-coms that were in fashion for a decade and then fell off the face of the Earth. Well, this new generation may not have the dot-com moniker, but they’re brought to you by the same slick venture capitalists who caused the tech wreck of the 1990s – wiping out millions of investors.

But it seems no one really cares about that anymore. Get this: In the third quarter, VCs raised $5.54 billion, or 78% more than in the second quarter. Now I know that there are no 12-step programs for reckless VCs – and that’s cause for my concern. Because flush with all that new cash, VCs are bound to go on another wild bender…that could only spell trouble for small-cap investors

Here’s why…

With the millions that VCs have raised from insurance companies, banks and other big institutional investors, they have to deliver huge profits – or they can’t go back to the well for more. At the same time, VCs have been sinking their money into increasingly perilous companies – for example, health sciences startups. So far this year, young companies involved in biotech and medical devices have absorbed 25% of all VC funding – hitting historical highs. Yet if you examine the track record of health sciences IPOs from January-August this year, 60% are trading lower than their initial offering price.

That’s not exactly sobering news. Now, with their pockets overflowing with a fresh cash infusion, things are bound to get worse. And that means by 2005 or 2006 we could see a graduating class of newfangled small-cap investments that appear too good to be true.

Sound familiar? It should. Because I’m talking about the same breed of VCs that brought us the greatest crash-and-burn investments in a century…ridiculous concept companies such as WebVan, eToys and Pets.com. Combined, those three fiascos laid waste to $650 million in the time it takes to get an MBA.

Check out the numbers…

eToys peaked at $84.25 in October 1999, then dropped to 3 cents some 18 months later. And those pitiable investors who held WebVan stock got annihilated – especially if they rode it all the way down from a high of $127.50 to a pathetic 6 cents. While Pets.com didn’t reach the rarified heights of WebVan, it plunged from $14 to 22 cents – an excruciating loss of 98.4%.

If VCs want to sink someone else’s money into lamebrained companies run by arrogant SOBs, well, as the saying goes, it’s a free country. But the reason investors got burned so badly in the late 1990s was that they strayed from the basics…from believing in the business fundamentals that make for a great new public company.

And it’s the fundamentals that we’re always emphasizing here at Penny Sleuth. In our Oct. 22 issue, James stressed, “Persistence, persistence, persistence.” But that doesn’t just mean perpetual optimism. It also means sticking with the best investment fundamentals, and by doing so, ending up a winner…big time.

As you start to see the VC graduating class of 2004 and 2005 hit the public markets within the next year or so, we’re advising that you stand firm on your investment criteria.

For example…

Look for money in the bank and a healthy cash flow. Small companies that are still developing products rely on cash. If they manage to generate sufficient profits to fund their day-to-day operations plus R&D, that helps ensure their long-term success – and profits for you.

Look for growth and value, two critical attributes that Warren Buffet said are “joined at the hip.” Growth will be driven by sold quarter-after-quarter sales. And better yet, these sales will come from increasingly larger customers. Value is rooted in one of the basic tenets of small-cap investing: that the top small-cap companies are ignored by Wall Street – depressing the stock price of a fundamentally sound company.

And look for insider buying. If you see that the people who know the company better than anyone else on the planet are spending their own hard-earned cash to buy the stock on the open market, that’s one of the best bullish indicators around – and a signal that you should consider getting in on it yourself.

When it comes to small-cap stocks, there will always be companies that are touted as overnight successes. And we know that it’s tempting to load up. But beware. If it sounds too good to be true, it is too good to be true.

Happy investing,

Irwin Greenstein

November 05, 2004

How Not to Lose $650 Million was originally featured in the Penny Sleuth.

*** Persistence, persistence, persistence. Whether you are a baseball player or a small-cap investor, the ones with the most persistence get the best results in the end.

Johnny Damon, the Boston Red Sox center fielder, is an all-star-caliber player. No question about it. But he was having a terrible series against the rival New York Yankees in the American League Championship Series this week.

During the first six games of the best-of-seven, winner-take-all bash, Damon looked ugly. He went just three for 29 at the plate – batting a miserable .103. It was the worst stint of his entire baseball career – even going back to his days of Little League. But he didn’t give up.

When Boston needed its center fielder the most, he came through. In game seven, the final game of the series, Damon broke out with three hits – including a two-run homer and a grand slam. He single-handedly dismantled the Yankees and gave his team a one-way ticket to the World Series.

Although I am not a Boston fan (I’ll stick by my Baltimore Orioles through thick and thin!), I did appreciate Damon’s effort – and that of the entire Boston Red Sox team. It’s nice to see persistence pay off – to see someone keep their head held high even when the chips are stacked against them.

And as a small-cap investor, persistence is a critical part of success.

One of the most frustrating aspects of being a small-cap analyst is finding out how many readers bail because one or two recommendations fall in price. People don’t pay for losers (man, I’ve heard that one before!). Everyone wants winners all the time. Well, unfortunately that isn’t possible.

Stock rise, and stocks fall. Sometimes you win, and sometimes you lose. But the people who quit because of one bad stock never give themselves the chance to win. And believe me, as long as the market exists, there will be winners -most of which will be small-cap stocks.

Every Friday, Investor.com lists the top-performing stocks (trading for $5 or more) on the major exchanges. This week, the top gainer was Isonics Corp. – a small-cap stock with a market cap under $100 million. (To give you a measuring stick of how small that is, Microsoft has a market cap of $305 billion!) It rose 41.5% on news it would develop portable explosive detection technology for the homeland security and semiconductor markets. That’s a huge deal for a small-cap company.

A new product launch, a new contract or even a solid earnings announcement can cause a massive rise in a company’s stock price. And Isonics is living proof of that. Show me a large-cap stock that has risen that much in six months – let alone a week! You may find one or two, but that’s about it. The small-cap market is chock full of such winners.

This week, nine of the top 10 performing stocks on the market were small-caps with a market cap of under $1 billion. Take a look at the list for yourself…

- Isonics Corp. (ISON:NASDAQ), market cap $95.9 million, rose 41.5%.
- The Robert Mondavi Corp. (MOND:NASDAQ), market cap $871.9 million, rose 34.4%.
- Polydex Pharmaceuticals Ltd. (POLXF:NASDAQ), market cap $20.5 million, rose 20.5%.
- Children’s Place Retail Stores (PLCE:NASDAQ), market cap $770.2 million, rose 21.3%.
- Sigmatel, Inc. (SGTL:NASDAQ), market cap $974.5 million, rose 26.5%.
- Select Medical Corp. (SEM:NYSE), market cap $1.7 billion, rose 20.9%.
- China Automotive Systems (CAAS:NASDAQ), market cap $270.7 million, rose 13.4%.
- Optibase Ltd. (OBAS:NASDAQ), market cap $72.1 million, rose 20.9%.
- Advanced Magnetics, Inc. (AVM:AMEX), market cap $114.7, rose 14.5%.
- OraSure Technologies, Inc. (OSUR:NASDAQ), market cap $308.6 million, rose 17.9%.

Of course, I can’t guarantee what stocks will be on this list next week, my small-cap friends. If I could, I’d be the richest man alive.

But I do know that resident Penny Sleuth Irwin Greenstein has figured out a way to help increase your chances of finding the high-risers. He’s run across an indicator that measures where some of the smartest (and richest) investors are putting their money right now.

Irwin, I pass the baton to you…

Where 2,800 Entrepreneurs Are Putting Their Money

It was a “tipping point” in Silicon Valley…when digital content was migrating from CD-ROMs to the Internet. I had established the regional office of a successful Los Angeles public-relations agency. Back then, we truly believed that our experience with TV could help the millions of new Web sites get coverage in the press to attract more “eyeballs.” That’s when I got the phone call…

An old friend of mine, who had already struck it rich in high-tech and moved to Honolulu, rang me up one afternoon. I remember how he had sworn up and down he was burnt out on tech. Never again would he run another startup. He looked forward to spending his days managing his $100 million from his magnificent ocean-view home office.

Who was he kidding? Once a tech junkie, always a tech junkie.

In that fateful phone call, he was fired up about a new company he wanted to launch. He talked about nutty stuff: hardened data centers, undersea broadband and millisecond downloads. Would I handle media relations for the launch? Since he’d be in San Francisco the following week for venture-capitalist presentations, I invited him to dinner at Boulevard. I figured the worst case was I’d have a perfect martini, a wonderful dinner and an interesting conversation.

How could I know that that dinner would change my life?

Over a bottle of Porter Creek Chardonnay and grilled monkfish, my friend laid out a plan for one of the most advanced data networks in the world. He had already recruited Cisco’s best and brightest to build it – pulling in the guys who literally wrote the book on Cisco routers. Whereas most networks were U.S.-centric (giving American users better performance), his idea was to launch a network where people in the United States, Europe and Asia all enjoyed the same incredible performance benefits for multifaceted data.

By the time the blackberry cobbler arrived for dessert, I had signed on with him. And we made history…

That company went on to create new market segments such as Web hosting, content delivery and managed services… pulling in millions in venture funding and ultimately revenues from corporate customers.

Thinking back to that dinner, I remembered my friend being so incredibly passionate about his idea…willing to do whatever it took to make the company an enormous success.

Now imagine if you could tap into the minds of the greatest entrepreneurs to find out where they were investing their blood, sweat and tears (and money). If you could, you would have the opportunity to invest in the hottest sectors, the hottest new technologies, and the hottest new companies all the time – before anyone else.

Sound impossible? Well, it’s not.

Sector Investing

There’s an index every small-cap investor should know about. It’s called the vFinance Entrepreneurial Confidence Index (but goes by VECI). Created by vFinance, Inc., the VECI uses online polling to pick the brains of entrepreneurs seeking capital and investors looking to put their money into the next big thing. The site is visited by more than a million entrepreneurs and investors every year – making it a magnet for innovative ideas.

The brains behind the Web site at vFinance, Inc. are among the best-informed experts in emerging trends. That’s because the company has more than 10,000 clients worldwide on both sides of the equation: the entrepreneurs and the financiers who develop companies and sectors the same way the rest of us mow the lawn.

By “sectors,” we’re talking about widely recognized broad industry categories such as energy, health care and transportation. And the VECI measures which sectors are ripe for expansion and which ones are well on their way to crashing down. This kind of information is far more valuable than any simple stock indicator.

The beauty of the VECI is that it’s a model of simplicity. vFinance clients are invited to participate in an online survey that measures entrepreneurs’ sentiments. Number crunchers then convert those data into meaningful statistics – including segment attractiveness. For investors, putting money into a segment versus a single stock is the difference between trying to a hit target with a shotgun or a rifle.

Here’s why…

Of the 8,856 publicly traded companies, maybe a handful will rise significantly in a given week, month or even a year. That’s it. And picking those winners can be tough, tough work. So instead of blindly trying to invest in the hottest stock – you can figure out what the hottest sector is and invest in several highflying stocks. And it just so happens that it’s the small-cap stocks that usually lead the way in any given index.

For example…

As of mid-October, the 2,800 entrepreneurs participating in the most recent VECI online survey had indicated a high level of confidence in gold and silver companies. In support of that, the bellwether Philadelphia Gold and Silver Index has risen over the past three months from $87.78 on July 20 to $101.68 on Oct. 20 – a boost of 15.8%. Exactly how good is that?

Well, the Russell 2000 small-cap index had gone from $564.19 to $569.26 during the same three-month period – for a humble uptick of 0.9%. So a gold and silver sector play would have yielded a breathtaking 1,655.6% more on your investment than the Russell 2000.

Digging a little deeper, there were some stellar gold and silver small-cap performers. Among them was Coeur d’Alene Mines Corp., whose same three-month results were up 16.2% – virtually tracking the Philadelphia Gold and Silver Index…and delivering one more piece of evidence on the prowess of the VECI (and about our sister publication, Penny Stock Fortunes, which nailed a staggering 221.05% profit on Coeur d’Alene Mines). And by the way, although Coeur d’Alene Mines only slightly outperformed the Philadelphia Gold and Silver Index, it crushed the Russell 2000 by 1,700% during the same three-month period.

But gold and silver wasn’t the only sector sizzler that entrepreneurs were attracted to in the survey. The other leaders were music production and energy, specifically oil and gas.

For me, the VECI fills a vacuum that was left when the tech bubble popped. When my entrepreneur friend and I were working together, there was a glut of so-called new economy publications like The Industry Standard, Forbes ASAP and Red Herring. They really took the pulse of venture capitalists and entrepreneurs – the visionaries who created breakthrough sectors such as Internet infrastructure, e-commerce and electronic gaming.

With those publications relegated to the dustbin, the VECI seems like a great replacement. In fact, it’s even better, because it’s devoid of the hype that characterized one of the most prolific sector-creation periods in modern history.

Is the VECI foolproof? No. Because even my entrepreneur friend invested in a few duds…but he also placed some incredibly lucrative bets on startups that may be the next sector stars of the small-cap universe.

For more information about the VECI, visit www.vfinance.com/eci.

Happy investing,

Irwin Greenstein

October 22, 2004

Where 2,800 Entrepreneurs Are Putting Their Money was originally featured in the Penny Sleuth.