StreetAuthority Presents: The Untapped Wealth Of 'The Forgotten Market'

Chris Carson's picture

Wednesday, December 24, 2014 - 12:00pm

by Chris Carson

There is something refreshing about being awake while the rest of the world sleeps. As I walk to work, I breathe the purest air of the day, drink my morning coffee while gazing at the moon and enjoy the sound of... silence. Not even the birds are awake.

Oh how I miss the days of getting to the office before sunrise and leaving after sunset.

Some people surely curse this lifestyle. And, after living it, I understand how such a schedule can get tiring. But being young and ambitious has its perks -- mainly being able to function off of a few hours of sleep. Enduring long hours is the norm for individuals in the money management industry.
You see, I had the unique experience of working for a money-manager right out of college in the beautiful state of Colorado.

This portfolio manager I worked for was spectacular. He doesn't have an Ivy League degree -- he didn’t need it. He's one of those self-made guys that you hear stories about.

What he has are decades of experience and, most importantly, a stellar reputation. He turned me on to the most interesting market sector I had ever been involved in: small-cap stocks.

These aren't the Apples, Caterpillars or Facebooks of the world. No, they're much smaller. For instance, the median market capitalization of the Russell 2000 Index is a measly $713 million, compared to the S&P 500's $38 billion.

Though small-cap investing isn't for everyone, the market is full of opportunity for diligent investors.

Of the many lessons my former boss taught me, the most important was his pre-market routine.

Before the opening bell, I went through the same routine each morning:

1) Consume and digest the overnight macro news developments and economic data, and then check the futures markets.

2) Look for any stock-specific news or premarket action in all of our numerous holdings.

3) Check if any of our stocks were moving before the open, and if so, then figure out why.

These three steps provide a snapshot of what to expect when the market opens.

This routine may not be necessary for every investor. But if you actively manage your own portfolio, then a regular routine like this should be an integral part of your investing habit. Just like showering or brushing your teeth.

That's especially true if you're investing in small cap stocks.

You see, being in the know is far more important in the small-cap sector than it is investing in large-cap stocks. That's because small caps have less coverage in the analyst community and financial media than their large cap brothers, so it's important to stay abreast of current information. Any sort of development -- from a valuation disconnect to a key acquisition to institutional buying -- can have a serious impact on the share price.

It's for these reasons that small cap stocks tend to outperform their larger counterparts. In fact, according to investment-consulting firm Ibbotson Associates, small caps have returned an average of more than 12% per year between 1927 and 2007. Large caps, meanwhile, have returned just over an average of 10% per year during that same time period.

To visualize how doing your homework with these types of stocks could have paid off for investors recently, just look at the performance of the Russell 2000 index, a widely used metric for the small-cap sector.

Over the last 10 years, the Russell 2000 returned about 93%, compared to the S&P 500's 76%.

Imagine what you could have made if you had weeded out the index's weakest small caps and only invested in the top performers. The results would be even more impressive.

As I said above, the market is littered with opportunities. In fact, some of the most well-known companies of today started as small caps: Monster Beverage, Green Mountain Coffee Roasters and Deckers Outdoor (maker of Uggs boots), to name a few

 

If you had invested in these companies ten years ago, you would have made a killing.
 

But these opportunities don't come without risk.

In a recent Bloomberg interview, Carl Icahn, a prominent activist investor known for his candor, summed up that risk when he was asked, "Is there a mistake a lot of investors make?"

His response: "Yeah, they invest. I'm being facetious, but not completely. Investing can be very dangerous..."

Though he was half joking, Icahn is spot on. Investing can be dangerous -- especially when it comes to small caps. But as you can also see from the data I mentioned above, the rewards can be great.

There are a number of considerations to make before jumping in and buying a stock -- that's the reason doing your homework is so integral to successful investing.

In the coming weeks StreetAuthority will be producing an in-depth series of articles focused on dissecting, understanding and investing in small-cap stocks. We will do the drudgery of waking up early, analyzing the trends and crunching the numbers, so you may better understand this misunderstood, yet lucrative market.

Action To Take --> Stay tuned for our first article in the series in January 2015. But don't wait around on us -- keep a close eye on the stocks you own. There's plenty of risk out there in the markets. There are also plenty of opportunities to find cheap, small companies that aren’t subject to the market hype that many of the most well-known companies must endure. Those are the opportunities we'll be looking for.
 

If you're looking to get started in small cap investing (or investing in any asset class for that matter), our Maximum Profit newsletter has a portfolio of small-caps stocks and a proven track record of excellence. This system identifies stocks with strong momentum and has lead investors to double and triple-digit gains. For more information on StreetAuthority's best-performing advisory, click here.

 

Chris Carson does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.