These Stocks Will Burn You

In his article "The Market's 10 Best Stocks," my colleague Tim Hanson pointed out the benefits of searching for the next multibagger success stories among the smallest of companies.

And I agree with him: The best stocks of the next decade will not be huge companies. Why not? This chart should explain. Look how large each of these solid businesses would become if they increased just 10 times in value over the next decade.

Company

Current Market Cap (billions)

10-Bagger Market Cap (trillions)

General Electric (NYSE: GE  )

$288

$2.9

Citigroup (NYSE: C  )

$107

$1.1

Bank of America (NYSE: BAC  )

$130

$1.3

Pfizer (NYSE: PFE  )

$120

$1.2

Intel (Nasdaq: INTC  )

$119

$1.2

Google (Nasdaq: GOOG  )

$179

$1.8

Cisco Systems (Nasdaq: CSCO  )

$153

$1.5

While it's certainly possible, we probably won't have a trillion-dollar company by 2018 -- much less see any of these large caps turn into 20- or 30-baggers. So we can count the giants in that chart out of the running for best performer of the next decade.

Instead, the greatest chance for the greatest gains comes from the smallest of companies, like the Tiny Gems that Tom Gardner and the Motley Fool Hidden Gems team follow. These half-pint companies are capitalized at less than $200 million, and there's plenty of room for them to grow before they run into the headwinds of large numbers and their prospects become more limited.

But before you take a free trial and jump headfirst into the micro-cap waters, listen up: This ride is not for everybody.

Buckle up
With great potential reward comes great risk. Just as a tiny company has the greatest chance at outlandish gains, it also has the best chance of going belly-up. Bankrupt. Gone ... along with your money. And the volatility along the way to greatness or the graveyard may give you whiplash.

Thus, these Tiny Gems are best suited for risk-tolerant investors with a long-term outlook.

That said, two things can greatly reduce the chance that your portfolio will get torched by tanking Tinies:

  1. Believe the balance sheet. This is where you can tell whether a company is in danger. Little cash and large amounts of debt are a big warning sign, especially for businesses not yet turning a profit. Go back through the past several balance sheets. Is the company burning through cash? How fast? My advice: Stick to profitable companies with cash-to-debt ratios of at least 1.5.
  2. Buy a "basket" of these micro caps. In other words, allocate the amount of funds you normally would for one stock to several of the Tinies -- four or five, for example. That way, you're giving yourself more of a chance at finding at least one huge gainer, which will more than make up for it if one or two of the others lose most of their value.

Are you still ready to forge onward to Tinyland? Good. Start here for information on a free trial of Hidden Gems, whose official small-cap recommendations (which are larger than Tiny Gems) have returned an average of 31% since inception, versus 8% for identical amounts invested in the S&P 500.

This article was first published Jan. 30, 2006. It has been updated.

Rex Moore helps Tom and team pan for micro caps and is an analyst for Stock Advisor. He owns no companies mentioned in this article. Bank of America and Pfizer are Motley Fool Income Investor recommendations. Pfizer and Intel are Motley Fool Inside Value recommendations. The Motley Fool is investors helping investors.


Read/Post Comments (4) | Recommend This Article (3)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 22, 2008, at 2:56 PM, BuddyDeez wrote:

    First - I find this article helpful. As a small investor just getting started out, investing in small stocks and good companies is a must. With a basic portfolio you can manage 5-6 stocks for each large stock you own. This will give you a much better understanding on how percentages and daily growth can really factor into your trades. I am learning to turn to the balance sheet for vital information, but keeping current with industry happenings and trends will be a better way to get aquanted with a companies performance/potential versus the balance sheet.

  • Report this Comment On June 23, 2008, at 1:12 AM, ockhamsrazor wrote:

    i'm not trying to say that large-caps are the place to be, but you are drastically overstating your point. for one thing, you have omitted this little thing, called dividends, which historically have been where most profits come from in the market. real (ie non-tech) largecaps pay dividends; how many of your pennies do?

    the other omission, much more important in some ways, is the dreaded word "downside". you gripe about GE not being a "ten-bagger" but it is clearly a straw man; you yourself talk about diversification for the invariable losses. well, if you expect one "ten-bagger" and a couple losers, you have a benchmark a lot closer to 8% than 25%, don't you?

  • Report this Comment On June 23, 2008, at 1:24 AM, kamuirei wrote:

    Just don't forget about trading fees, taxes time and stress.

    I had fun trading for a bit... but in the end I decided that it's a heck of a lot easier to use an ETF for small caps. Cuts down on all the factors mentioned above. If you're a 20 something like me, there's no reason to take the risk.

    Look up AHM and FDG. I owned both 2 years ago. I sleep MUCH better with my ETFs.

    Small/Midcap ETFs: IJJ, IJS, VOE, VBR

  • Report this Comment On June 23, 2008, at 9:58 AM, macdanzig wrote:

    In all due respect to Rex, while I agree some exposure to micro-caps is a good thing this article suggests that one should do so in absence of large cap value and growth. The fact is that these stocks are the backbone of any portfolio. The suggestion that an investor shouldn't invest in such securities is really misleading. Furthermore measuring success of these securities based upon whether it's going to be a "10 bagger" is preposterous. If you double your money in 10 years that equates to an 8% return which while not stellar is respectable. The lower risk/reward is to be expected - that's why these kind of securities are foundational elements to any portfolio.

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