Tiny Companies With Huge Potential

Do micro caps deserve a place in your portfolio?

Dan Caplinger
Dan Caplinger
Jun 30, 2008 at 12:00AM

During risky times in the markets, many investors focus on solid, blue-chip stocks for their portfolio. But if you're looking to go for the glory of huge returns from your investment dollars, then you might want to think small -- really small.

This month's issue of the Motley Fool's mutual fund newsletter, Champion Funds, takes a look at micro-cap stock investing. The names you'll see in this tiny sector of the market won't turn heads at any cocktail parties you go to -- most people have never heard of them. By being an early investor in these young businesses, however, you put yourself in a prime position to cash in if they strike gold.

The basics of micro caps
Micro-cap stocks are among the smallest public companies you'll find, typically having market caps between $50 million and $300 million. Because of their diminutive size, these small businesses often escape the notice of Wall Street analysts, flying under the radar of even small-cap indexes like the Russell 2000.

Micro-cap stocks' appeal lies in  getting in early on what can become gigantic gains. Although some companies, such as search-master Google (NASDAQ:GOOG) and credit-card maven Visa (NYSE:V), are already too big, even at their IPOs, to qualify as tiny stocks, many others work their way up through the micro-cap ranks before finding ultimate success.

A quick fix from index funds
If you want to bet on the prospects of today's tiny upstarts becoming tomorrow's household names, you have a variety of ways to invest. Choosing individual companies is always an option. But keep in mind that you'll have to do your own homework, since some of the resources available on larger companies simply don't exist at this level.

Because of the added risk involved in tiny companies, you may feel more comfortable investing in funds. One exchange-traded fund, the iShares Russell Microcap ETF (NYSE:IWC), tracks Russell's index of 1,000 micro-cap stocks. Its top performers recently include stocks like McMoRan Exploration (NYSE:MMR) and Contango Oil & Gas (NYSE:MCF).

If you prefer to invest in an actively managed portfolio, there are plenty of specialty micro-cap mutual funds to choose from. Champion Funds lead advisor Amanda Kish looks at several promising choices in this month's newsletter.

Watch what you're buying
Before you decide to buy a micro-cap fund, however, keep in mind that even if your fund finds a successful company, it will probably only hold onto it for a relatively short time. As companies grow above a certain size, most funds will require managers to sell shares, in order to reinvest in smaller companies within the target market cap.

Unfortunately, that's the downside to micro-cap funds -- you miss out on the full appreciation potential that tiny companies offer. Once a company graduates to small- or mid-cap status, your fund will most likely have to sell it. If you're truly looking for the next Intel (NASDAQ:INTC) or Wal-Mart (NYSE:WMT), you know just how costly it can be to sell for a small profit and miss out on a potentially bright future.

If you'd like to learn more about micro-cap stocks -- or if you're just curious about what funds our experts are recommending for microcap exposure -- then help yourself to a free guest pass to Champion Funds. With a 30-day trial, you'll get access not just to the most recent article but to our archive of past issues, along with all our fund recommendations, model portfolios, and much more. There's no obligation.

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