TheStockAdvisor Advice

Thinking Small

No one will argue that there are huge returns to be made investing in Small and Micro Cap stocks, what some will contend is that the rewards do not equal the risk. As if investing in large cap stocks that begin with "E" and end in "ron" are safer. Depending on your goals and if your like me, your goal is to make money. A well balanced portfolio should have a portion allocated to speculative high return stocks.

Discovering small-cap stocks before the street does can be a challenge. We like to look for stocks in a hot sector that have the potential to be market leaders in their sectors. You'll find no shortage of newsletter gurus willing to show you the light and send you on that dream vacation, you know the one with the white sand beaches and the little umbrellas. Be wary of the many sites on the internet today that promise you returns of 500% or more, 499% or less is okay. I mean do you know what the taxes would be on a 500% short term capital gain??

To separate yourself from the sites out there that are strictly hype, look for balance and depth in the report. I received a report the other day from someone calling himself Gilly Gizzard or something, he sent me a ticker and a strong buy recommendation. I think the company made antler warmers for reindeer and was thinking about expanding into reindeer accessories, kind of like the GAP of the North Pole. The deal was, if I dropped my pastrami sandwich, cancelled my afternoon card game, called my broker and bought the stock this instant, I would be well positioned for the 2000% gain that was coming that afternoon as soon as General Motors found out that reindeer droppings can be converted into some kind of neo-thermal fuel that makes cars fly. Don't waste your time looking up neo-thermal fuel in the dictionary, it's not in there. But it sounded technical enough to me that if it's not already discovered, maybe we should be looking for it.

With small-cap stocks you will want to concentrate on a few key points that make a company go.

A) Management: Until a company has its ramp-up quarters (translation: losses) behind them and you have a clear view of earnings potential, management is crucial. Look for an experienced management team with past successes.

Avoid management teams that have directors with names like Sleepy, Dopey and Grouchy.

B) Market: You will want to find a company with a large market for its products, if the market exists and the product is competitive, you have growth.

I don't doubt the market for reindeer antler warmers is vast but since reindeer don't have pockets, I'm guessing their not carrying currency.

C) Scalable: The company needs to be able to produce their product or service in quantity should the market demand it. It serves no purpose to have a product that can not be delivered in a timely manner resulting in cancelled orders and missed opportunity.

Companies can avoid the scalability issue by selling their product at any of the online auction houses whereby you take orders, cash checks and literally have no product at all, just a pretty picture of what the product would look like if you actually had one. This saves on inventory costs too.

D) Margin: Look for companies with high margin products and services, companies with 40%+ margin on their products are able to free up a lot of room for other cash critical areas and have a better chance of turning profitable sooner.

Again, you can't beat those online auctions houses for 100% margin returns.

E) Proprietary: The companies products or services should be proprietary or at least unique enough to give it a distinct advantage. If not first to market with the product, look for a company that makes a better mousetrap.

Now... I'll have to give it to Gizzard boy on the proprietary product issue but one out of five isn't going to cut it.  

There are tremendous gains to be had in penny stocks if you research your stocks before you jump in. Having said that, the trick is performing your due diligence and we cannot stress this enough. We think you have the knowledge to separate the hype sites from those that actually provide you a service and with thatů We welcome you to the wonderful world of micro cap stocks, where else can you double your money in a day and discover neo-thermal fuel.


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