Money managers say small firms can yield big returns

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Size does matter when it comes to publicly traded companies.

While share prices for the big kahunas of the financial world — such as Wal-Mart, IBM and General Electric — have soared in recent months as the Dow Jones and the S&P 500 have hit record territory, money managers say smaller companies that are often ignored by Wall Street analysts and much of the investing public could yield better returns over the long haul.

“Individual investors have an opportunity with micro-cap stocks that they don’t have with large cap stocks that are heavily researched and followed by large fund managers,” said Bernard Carter, an investment strategist at Hapanowicz & Associates Financial Services, Downtown.

“There is a chance for small investors to find the micro-cap before it makes that large move,” he said. “It’s one of the few areas individual investors have an advantage over institutional investors.”

“Cap” is an abbreviation for “capitalization.” Market capitalization is calculated by multiplying the number of outstanding shares that a company has by its stock price.

Publicly traded companies with a market cap between $50 million and $300 million fall into the micro-cap category, while large cap companies such as Apple or McDonald’s — also called blue chips — are worth $5 billion or more.

Even as the stock market has been racing onward and upward for much of this year, investors had pulled nearly $13 billion out of small cap mutual funds and small cap exchange traded funds as of June 30, according to Lipper, a New York-based supplier of mutual fund information and research. Meanwhile, investors deposited $12 billion into large cap mutual funds during the same time frame.

As CEO of Merriman Holding Inc., a San Francisco investment bank, Jon Merriman advises, trades, researches and provides financing for companies with less than $1 billion in market capitalization. He said micro-caps, as a whole, are underinvested.

“Most people want dividend stocks and large cap stocks like Apple Computers,” Mr. Merriman said. “People are nervous about the market and feel those stocks are safer. But as an investor, you want to be a contrarian. As a contrarian investor, micro-caps are a good place to be.”

One recent micro-cap success story is RadNet (RDNT), a medical imaging company in Los Angeles whose share price climbed from $1.61 in January to $7 per share this week.

While every investor dreams of finding a stock that will double, triple or quadruple in value, even financial advisers who focus on micro-caps recommend that investors only risk what they can afford to lose. Micro-caps should only be used to diversify a portfolio.

Paul Brahim, CEO of BPU Investment Management Inc., Downtown, said data provided by Morningstar show there has been no real advantage to owning micro-cap stocks over the last 10 years. The S&P 500 outperformed the Russell Microcap Index over that time frame and did so with a lot less volatility.

“I’m convinced by the data that this segment simply offers more risk to the average investor,” Mr. Brahim said. “Over the last five years, there were only 13 of the 30 mutual funds in that category that outperformed the S&P 500.”

This sector is not for those easily spooked. The majority of micro-cap stocks and funds will not make the grade.

Mr. Carter, who runs a department at Hapanowicz that focuses on buying and selling micro-caps, said he starts by identifying companies that are experiencing some degree of financial stress.

He said a key component of his investment strategy related to micro-caps is that a company be on the cusp of an operational turnaround before he includes it in client portfolios.

“We react to that inflection point,” he said. “We wait until we see the whites of their eyes before we buy. We are looking for that turnaround event. We look for a stock that is left for dead, but it has all the infrastructure and management ready to implement the changes.”


Tim Grant: tgrant@post-gazette.com or 412-263-1591.

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