Let's start things off with a little quiz. While many of us know the stock market has averaged about 10% annual returns over the years, when was the last time it actually returned 10%... or anywhere close to it?
The answer: 1993, when the S&P 500 rose 7.1%.
Since then, the index has been crazy, returning -1.5%, 34%, 20%, 31%, 26.5%, 19.5%, -10%, -13%, -23%, and 26%. When it comes to the market, there's really no such thing as a "normal" year.
Here's how 2004 has behaved thus far:
|Index||2003 Returns||2004 YTD|
|S&P MidCap 400||31.6%||3.9%|
|S&P SmallCap 600||34.3%||8.5%|
Rather dull by comparison to the last several years, eh?
Small is exciting
If you've had trouble finding interesting stock ideas in the current stagnant market, you're not alone. We've all read that some of the world's top investors, such as Warren Buffett, are sitting on piles of cash because there just aren't many bargains presenting themselves out there.
For this reason -- and many more -- it makes sense to go hunting for smaller companies. Buffett and other large investors can't touch small caps because they can't buy enough shares to make any meaningful difference to their overall investment returns. That's good news for us, because fewer investors in the small-cap arena mean fewer geniuses, fewer bids in a given week or month, and more pricing inefficiencies.
So would you like to find good small-cap ideas? Good! Here's a little gift for you -- the complete Foolish 8 list as of Oct. 15. Many of you are familiar with the Foolish 8. Originally developed by David Gardner and published in the first edition of The Motley Fool Investment Guide, it attempts to identify profitable, rapid-growth, small-cap stocks, using the following eight criteria:
- Revenues: $500 million or less
- Earnings and sales growth: 25% or greater
- Net profit margin: 7% or greater
- Daily dollar volume: $1 million to $25 million
- Insider holdings: 10% or greater
- Share price: $7 or greater
- Relative strength: 90 or greater
- Operating cash flow: a positive number
It has performed admirably over the years according to the American Association of Individual Investors (AAII). This well-respected, not-for-profit company tracks various screens and, according to its data, the Foolish 8 has produced a 266% cumulative return from December 1997 (when it started tracking screen results) through last month. The S&P 500, by comparison, returned 15% in the same time frame.
(The Modified Foolish 8, which I developed several months ago, returned 397% during that period, according to AAII's backtested returns. That screen is featured each month only in Hidden Gems.)
|A.S.V.||ASVI||Sells track-driven all-season vehicles|
|Advanta||ADVNB||Financial services company serving the small-business market|
|Aldila||ALDA||Makes graphite golf shafts|
|Amedisys||AMED||Provides home health-care nursing services|
|CARBO Ceramics||CRR||Provides ceramic "proppants" to the oil and gas industry|
|Central European Media||CETV||Overseas commercial television operator|
|Dawson Geophysical||DWSN||Collects seismic data for oil and gas companies|
|Deckers Outdoor||DECK||Footwear and accessories maker|
|Edge Petroleum||EPEX||Oil and gas driller|
|First Horizon Pharm.||FHRX||Markets and sells brand-name prescription products|
|Hansen Natural||HANS||Specialty beverage maker|
|Innovative Solutions and Support||ISSC||Makes flight information equipment for aviators|
|Meridian Resource||TMR||Uses seismic technology to find oil and gas|
|NS Group||NSS||Makes steel casings for the oil and gas industry|
|Palomar Medical Technologies||PMTI||Makes laser devices for removal of hair, tattoos, and unspeakable things|
|Terra Nitrogen||TNH||Creates nitrogen fertilizer products and other gaseous stuff|
|Tsakos Energy Navigation||TNP||Provides marine transportation services to the oil industry|
|Ventiv Health||VTIV||Offers sales and marketing services to pharma and biotech companies|
|Vineyard National Bancorp||VNBC||California-based community bank for grapes|
With 19 companies passing the screen, the list is rather long this month. Which of these might turn out to be a wonderful success story such as Home Depot
1. Deckers Outdoor
2. Ventiv Health
3. The oil and gas industry has decent representation on the F8 list, and NS Group
4. Hansen Natural
Don't stop here...
I hope something in the list caught your eye and that you'll allocate a portion of your portfolio to small-cap stocks. I truly believe that, over time, they will help boost your overall returns.
Tom Gardner's small-cap recommendations have averaged a total return of 30% since he began piloting Hidden Gems in June 2003 (vs. a 3% gain for the S&P 500). You can see exactly how he chooses and values small companies with a 30-day free trial to the newsletter. I know you'll find it enjoyable. If not, it won't cost you a dime.