5 Stocks to Tap for the Coming Rally

It's coming -- an all-out recovery.

I don't know when (and I don't think anyone else knows when, either), but it's coming.

And that means it's time to invest in small-cap stocks.

History is repeating itself
During the last bear market -- when most stocks nose-dived -- small-cap stocks absolutely soared, handing savvy investors 22% a year over the next three years.

Their amazing run during the 2001-2002 recession was no fluke. Starting in the middle of the brutal recession of 1974, small caps made an epic run. Shooting up during the recession and extending their run long after the economy recovered, they returned 28% a year for nearly a decade.

And beginning in 1991, small caps powered right through a sharp downturn and kept gaining -- handing investors 116% over three years. 

The best part of all of these bits of history? Small caps started their run smack in the middle of the bear market -- not after the turnaround. And that means right now is a great time to buy.

How to buy in
If you want to hedge your small-cap bets, you could hope to enjoy similar returns this time around by investing in a nice ETF like the iShares S&P SmallCap 600 or the Vanguard Small-Cap Value ETF.

But even that limits you. Instead, invest in the healthy, competitive companies that could use the coming rally to build unbelievable returns.

It's happened before. Each of the stocks in the chart below were small caps transformed by a big rally into some of today's most well-known large caps:

Stock

Bear Market

Length of Small-Cap Rally

Gain

Wal-Mart (NYSE: WMT  )

1974

9 years

3100%

Dell Computers (Nasdaq: DELL  )

1991

3 years

237%

Research In Motion (Nasdaq: RIMM  )

2001

3 years

182%

What opportunities might be awaiting investors this time around?

Small caps idling on the launch pad
Right now, an irrational fear of further economic collapse is pushing some of today's best small-cap stocks down to epic lows.

Just have a look at the companies below. Each has seen its stock price fall dramatically over the past year. And each has seen incredible net income growth over the past five years (a sure sign of a healthy company):

Stock

Market Cap

1-Year Price Change

5-Year Net Income Growth Rate

Hexcel Corporation

1.01B

(54%)

254%

Olin Corporation

938M

(53%)

56%

Arch Coal (NYSE: ACI  )

2.4B

(77%)

24%

Frontier Oil Corporation (NYSE: FTO  )

1.46B

(47%)

102%

Tesoro Corporation (NYSE: TSO  )

1.96B

(38%)

31%

While these are not formal recommendations, I find it hard to believe that these small, profitable companies will stay at prices this low for long. Now's the time to dive in and get greedy.

But aren't small caps risky?
It's true that small caps tend to be more volatile over the short term than their larger brethren, and small companies can face more business risk than larger, more entrenched corporations. And sometimes it's far too easy to get caught up in the "story" and money-making "potential" of small caps.

For example, I dove in headfirst when I invested in Sirius XM Radio (Nasdaq: SIRI  ) back in March of 2008. I was more concerned with watching my shares rocket up after the merger than the fact that the company was hemorrhaging hundreds of millions. That would be why my shares are currently down 86%.

Like every other investment, small caps require us to be selective and attentive -- because the truly healthy small companies are the ones that will the lead the next bull market and extend their gains for years to come.

Adding just a select few small companies to your portfolio can have a dramatic effect on your long-term wealth. And this is an incredible time to invest in small caps.

That's what the advisors at our Motley Fool Hidden Gems investing service are doing -- they're investing $250,000 of The Motley Fool's money in the best small caps around. You can see all of their top picks free for 30 days -- just click here to get started. There's no obligation to subscribe.

Already subscribe to Hidden Gems? Log in here.

Ryan McLimans is holding his shares of Sirius indefinitely. Wal-Mart and Dell are Motley Fool Inside Value recommendations. The Motley Fool owns shares of the Vanguard Small-Cap Value Index. The Motley Fool has a disclosure policy.


Read/Post Comments (9) | Recommend This Article (38)

Comments from our Foolish Readers

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 17, 2009, at 2:41 PM, Fredlee009 wrote:

    Nice SiriusXM throw in. What profits were you watching? you mean for like 3 mintues. You just proved you dont know the stock. Yes, im sure you forgot about all the debt. The media only mentioned it everyday. I dont believe your story. Makes no sense, since I know the facts. You dont sound credible to me. Nice purposeful bash on a great company. You as obvious as a mugger in broad daylight.

  • Report this Comment On June 17, 2009, at 2:42 PM, Fredlee009 wrote:

    "Please be respectful with your comments"

    Ok, when your respectful with your articles, and stop fearmongering a great companies image. Not why you write articles is it? Then dont do it. Write facts. Thats not facts, thats bs.

  • Report this Comment On June 17, 2009, at 2:54 PM, jdgee2 wrote:

    In fairness to Ryan McLimans : At the bottom of this article, you can read the following:

    "Ryan McLimans is holding his shares of Sirius indefinitely." [end quote]

    Best Wishes,

    Jon (long siri)

  • Report this Comment On June 17, 2009, at 2:55 PM, XMFTheNew wrote:

    Fredlee009,

    I wasn't watching any profits with Sirius, as the company was and is still unprofitable. My point was, there was a lot of hype surrounding the stock. And a lot of investors were blind-sided by the stock's poor performance after the merger. (Especially after Mel Karmazin's media tour touting all the benefits of the merger.)

    I acknowledged the fact the company was losing money left and right. And that I was definitely thrown for a loop when it plummeted and was threatening to be de-listed from the Nasdaq.

    I own shares and I'm a subscriber. So I truly hope things turn around but there's no denying it was a risky play at the time.

  • Report this Comment On June 17, 2009, at 3:51 PM, trammen0 wrote:

    You guys are a pathetic!! I think you guys are part of the 171,000,000 shorts on the SIRI stock??? every article you have to bash this stock, you guys have my vote to be the first goup investigated by the SEC.

  • Report this Comment On June 17, 2009, at 4:11 PM, XMFTheNew wrote:

    trammen0,

    Just to be clear... I own Sirius shares (currently down 86%). My intent wasn't to bash the stock... just pointing it out as an example of a "story stock" that was really hyped up and fell through in the short-term.

    I own a satellite radio and enjoy the service. As a shareholder I hope Sirius prevails over the long-haul.

  • Report this Comment On June 17, 2009, at 4:25 PM, JimboUSMC17 wrote:

    I just think that many of us shareholders are tired of seeing SIRI mentioned in every other Fool article. A majority of the times SIRI is mentioned in a negative way.

    You just got caught in the middle. lol

    GL with your SIRI shares.

    Jimbo (long on SIRI)

  • Report this Comment On June 17, 2009, at 9:22 PM, sopsychobilly wrote:

    What's with the hostiles? Hey fellas I have some advice for you, "love your stocks, don't LOVE your stocks." If you know what I mean.

  • Report this Comment On August 20, 2009, at 1:07 AM, UltraContrarian wrote:

    I think most people think of companies with >$1B market caps as mid caps. Those are some pretty big companies.

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