You’d Be Stupid to Buy These Stocks

Recs

16

"Now is an absolutely ridiculous time to buy small-cap stocks.

"You'd be a dope to snap up shares of companies like Novavax (Nasdaq: NVAX), BioCryst Pharmaceuticals (Nasdaq: BCRX), Microvision (Nasdaq: MVIS), and Vanda Pharmaceuticals (Nasdaq: VNDA) -- all of which are up more than 500% since March's market low."

That's what you might be hearing, now that the small-cap Russell 2000 Index is outpacing the S&P 500 by more than 19 percentage points. Even The Wall Street Journal predicts that the small-cap rally is set to come screeching to a halt. 

But don't be duped ...
Just because many small-cap stocks have seen a huge increase in the last few months doesn't mean you should avoid all of them.

First, no one accurately called the market's bottom in March, so it's dubious whether anyone now has the ability to call a top just a few months later.

Second, the Russell 2000's sharp rise has largely been driven by the speculative bidding-up of penny stocks (stocks with share prices below $5). Many companies whose share prices exceeded $5 per share in March have not shared in the astronomically high returns -- including companies whose fundamentals have actually improved year to date.

This trend isn't unique to small caps. In fact, S&P 500 stocks whose prices fell below $5 during this bear market -- including Citigroup (NYSE: C), Gannett (NYSE: GCI), and Huntington Bancshares (Nasdaq: HBAN) -- have been some of the highest gainers in that index, with each up more than 300% since the bottom.

But this still raises the question: Why have penny stocks risen quicker than non-penny stocks?

Pain, baby, pain
Behavioral psychologists refer to the "pain of paying" -- the mental barrier we face when parting with our cash. The higher the cost, the higher the barrier.

For investors focusing on share price (instead of, say, underlying company quality), it's less painful to toss an extra dime per share into purchasing a penny stock -- even if that dime represents twice what the stock was trading for the day before -- than it is to toss in an extra $5 per share for a stock that was trading for more than $100 a share the day before.

Rational? Certainly not.

However, this speculative irrationality presents the savvy small-cap investor with a great opportunity.

How to cash in on small-cap movement
There are two ways you can profit from the rush to penny stocks:

  1. Join the rush, and wager your hard-earned money by guessing which penny stock might rise next.
  2. Invest in small-cap companies whose fundamentals have been improving, but which are still undervalued by the market.

As much as we'd all love to have a stock shoot up nearly 5,000% in just a few months -- as penny-stock micro-cap Diedrich Coffee recently did -- at the end of the day, the first tactic is nothing but a risky crapshoot.

So though your inclination might be to go for the gusto to make up for losses, the second option is really the only way to set yourself up with a portfolio that will grow your wealth at above-average rates over long periods of time.

After all, the best small caps have the ability to consistently outperform -- which is why they have consistently been the top-performing stocks of the past four years.

Time to be smart
One company I think you'd be smart to buy right now -- one that I have my eye on, and which the team at Motley Fool Hidden Gems recently purchased shares of -- is Brink's Home Security.

Brink’s has a market cap of just $1.4 billion, and it boasts a clean balance sheet, with $103 million in cash and zero debt. Best of all, it's currently trading for just more than eight times the Hidden Gems team's calculation of steady-state cash flow.

The stock has risen significantly since the end of 2008 -- but the team still expects market-beating returns over the next two to three years, with very little risk. 

You can browse through their whole investment thesis, and examine their in-depth valuation of this company and many others, completely free with a trial membership to Hidden Gems. Click here for more information.

Already subscribe to Hidden Gems? Log in at the top of this page.

This article was originally published Aug. 24, 2009. It has been updated.

Adam J. Wiederman owns no shares of the companies mentioned above. The Motley Fool owns shares of Brink's Home Security, a Motley Fool Hidden Gems recommendation. The Fool's disclosure policy is anything but stupid.

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 September 30, 2009, at 4:24 PM, DogDayAftern00n wrote:

    This article is completely useless. DNDN is up over 1,000% since it bottomed earlier this year, but the stock has solid fundamentals and consequently is a screaming buy.

    BCRX is also another stock with solid fundamentals. Just because it's up quite a bit from the low lows earlier this year doesn't mean that it isn't a good company and doesn't have a bright future ahead of it.

    Again, useless article. But then again, they don't call them "FOOLS" for nothing.

  • Report this Comment On September 30, 2009, at 5:32 PM, MadStabber wrote:

    Uhhh hello... I picked the very bottom on 2/20 in my Foolish Blog and pick a "correction" before the Oct holiday. How did you Foolishly miss CHWG as the next 50 bagger? Their 3 liter bottling plant is scheduled to open in November. I do appreciate your respect for MVIS, the next company to project pictures on the MOON!

    Madfoolowner of MVIS and CHWG

  • Report this Comment On September 30, 2009, at 11:49 PM, UraLoser123 wrote:

    YOU WOULD BE REALLY STUPIS TO TAKE ADVICE FROM THIS TRULY PATHETIC SITE. I LOVE IT WHEN THEY TELL YOU WHAT STOCKS TO BUY. THEY SIT BACK WHILE THE IDIOTS WHO LISTEN TO THEIR INSANE RECOMMENDATIONS BUY THESE WORTHLESS STOCKS, AND SELL AFTER REALITY SETS IN. TRULY, THESE IDIOTS ALONG WITH CRAMER WHO PULL THIS CRAP SHOULD BE INVESTIGATED. HOW IS THIS CRAP NOT ILLEGAL?

  • Report this Comment On October 01, 2009, at 12:40 AM, stockmajor wrote:

    Adam, I liked your article, and I LOVE the Motley Fool. What a blessing and a resource this site provides!

    So, yes, I'm a Fool and loving it! And I'm laughing all the way to the bank. Oh, by the way, Cramer has helped me to earn some Mad Money along the way, also. So, Fool On!

  • Report this Comment On October 01, 2009, at 10:30 AM, jthinker wrote:

    Definitely fools, who call themselves experts, should be not trusted with their opinions. It looks like they are sucking their "expertise" out of thing air and that "expertise" has nothing to do with real life.

    It is a no brainer to talk or write about past events with smart looking face, but they dare to predict future and give advice to people; just don't listen to them, let them be where fools are supposed to be - in a "fool house".

    The simple question is, What do they "Motley FOOLS" really know about real businesses they dare to talk about?

    The answer is obvious - nothing.

  • Report this Comment On October 01, 2009, at 4:42 PM, S79T285 wrote:

    Mr. Wiederman:

    It is a fairly common trick, in among the unethical of financial journalists, to look predictive by increasing volatility at cusps. You exploit fear and greed to enhance your stature as predictors of stock prices.

    When Novavax was under a buck, you called it a deathbed stock. When it was over 5, you said it was "ready to soar." Neither of these statements focused on the truth, which is that medical advances for the benefit of all mankind are fragile, and not rationally understood by the financial markets. Your comments make the misunderstanding all the worse.

    When Novavax was, to use a medical term, in extremis, you stomped on it with the steel toed boot of a stormtrooper. Had you suceeded in precipitating bankruptcy, you would have benefited some shortsellers. But you do not understand the future, Mr. Weiderman. For every nickel they make, a child dies, not now, but in the future. The future counts very much, Mr. Weiderman. You were once a child. It is not inconceivable that some day, you could hold a child in your hands, dying but for a vaccine that could have been made by Novavax, or another startup.

    You seem to take pride in adherence to the ethics portrayed by Michael Douglas. I am sure that your market metrics indicate that you are succeeding well in increasing revenues of the Motley Fool. But there is a hidden cost, Mr. Wiederman. A lot of people now hate you. I despise you. If anyone ever refers to an opinion from your website, I will tell them this story. I will illuminate the entirely legal/yet unethical manipulations you engage in.

    I hope you fall hard.

  • Report this Comment On October 02, 2009, at 12:04 AM, mirro7 wrote:

    There is an old saying: “a rolling stone gathers no mass.”

    So is the “trader” of the modern age… like a rolling stone that gather no [meaning full] portfolio mass in the long term. Let’s face it. A trader is not an investor and your advice is directed towards such traders. I hope it is, because if you are preaching your insanely dumb sermon to the investor choir you are foolishly naïve and should be committed to “investment education” for the next six months.

    I have always believed in investing in companies that ride the wave of change or bring about the paradigm shift with an eye on the long term growth prospects.

    I’m one of those old timers that invested in Intel during its early days as a company… in the early 80’s. I recall buying some shares for a total cost of $1,000 dollars. That was lot of money in those days and commission paid was a disgrace. Stock brokers were king of the hill and roamed the streets like God’s gift to humanity.

    I had to liquidate all my position in Intel during the Dot Com bust of 2000… around May of that year. I think it was just before the last stock split the company had. However, it was not all that bad, because I managed to sell pretty close to the all time high and I remember bragging about my good fortune and fortitude to have stayed the course to make over 14,000% profit… for a net gain of over $140,000 dollars. That’s right… over $140,000 in profit including dividends and the stock splits.

    In the last 30 odd years that I have been investing, I had my share of good fortune and misfortune. However, what’s important is the fact that I managed to secure my financial future and live today to talk about my strategy of investing in companies that ride the wave of change or bring about a paradigm shift.

    Some of these companies have grown to be huge enterprises and have made their early investors, like me, over 10,000% or over since their inception. Some day, I will tell you about my other [early] investment in companies like Dell, Qualcomm, Microsoft, Cisco, Healthsouth [after the 2003 perfect storm] and most recently Microvision. And while Dell has had disappointing returns since the turn of the century, its business is still strong and investors have not even come close to losing everything.

    Currently, I’m out of all the stocks except Microvision [Nasdaq: MVIS]. The past performers in my portfolio have served well. However, these companies like Intel, Dell, Qualcomm, Microsoft and Healthsouth are past their hyper growth phase and are now too big and are just slow earnings growth vehicles. No disrespect to these fine companies… it’s just that they don’t fit the “hyper growth” company model any more.

    My only stock holding now, besides an options income portfolio, is Microvision. If you would like to find out why I consider Microvision to be the next 50,000% profit producer, then click on the link to the following blog post and make sure to read all the related articles.

    Access to this blog is free and author’s profile will tell you why he is taking this time and making an effort to reach out and share information that already exists in the Internet sphere…

    http://mirro7.blogspot.com/2009_10_01_archive.html

    http://mirro7.blogspot.com/2009/09/microvision-from-here-to-...

    http://mirro7.blogspot.com/2009/09/yes-virginia-its-intel-in...

    Anant

  • Report this Comment On October 02, 2009, at 8:25 AM, vefrancine wrote:

    I'm a retired Virologist and think NVAX has a very good model that will revolutionise vaccine production. Hang in there and don't listen to these fools.

  • Report this Comment On October 04, 2009, at 10:40 AM, jthinker wrote:

    Just a question, Is there any legal way to shut down those "Motley FOOLS"? How much longer those self-proclaimed experts will mess with peoples' minds and cultivate the culture of short-sited followers?

    IT NEEDS TO BE STOPPED ONCE AND FOREVER. How many fools does this country need?

    It is enough already.

  • Report this Comment On October 21, 2009, at 4:41 PM, liferlm wrote:

    If you wisemen would read beyond the headline you might come to a different conclusion regarding these MF's. (They are not actually claiming MVIS, NVAX, etc. ARE overvalued.) Now, don't you feel foolish?

Add your comment.

Compare Brokers

TD AMERITRADE
more info
ShareBuilder
more info
Power E*Trade

more info
Scottrade
more info
Fool Disclosure

DocumentId: 996545, ~/Articles/ArticleHandler.aspx, 11/24/2009 7:13:56 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

The Must-Read Story on Fool.com
Why Investors Should Be Excited for a Bank Breakup

Related Tickers

11/23/2009 4:02 PM
GCI $10.47 Up +0.09 +0.87%
Gannett Co., Inc. CAPS Rating: **
NVAX $3.17 Down -0.11 -3.35%
Novavax, Inc. CAPS Rating: *
BCRX $8.90 Down -0.65 -6.81%
BioCryst Pharmaceu… CAPS Rating: *
HBAN $3.80 Up +0.02 +0.53%
Huntington Bancsha… CAPS Rating: **
VNDA $10.42 Up +0.14 +1.36%
Vanda Pharmaceutic… CAPS Rating: *
C $4.28 Up +0.08 +1.90%
Citigroup, Inc. CAPS Rating: ***
MVIS $3.43 Up +0.11 +3.31%
Microvision, Inc. CAPS Rating: ***

Community: Investing Wiki

Term Of The Hour

Asset: An asset is any property owned by a company or person that has economic value, especially those that can be converted to cash.

Want to learn more or edit this definition?
Click here to read more!