Me, I was working on a column a lot like this one. In fact, it was just like this one. That's because, in September 2003, I stumbled on two facts that, looking back, could have made us a lot of money.
And you can still cash in
Which is why I'm repeating them right now:
- I still don't believe the historic rally in small-company stocks is kaput.
- If you don't own small companies in your portfolio, don't assume you're covered by your mutual funds. Not even if they are so-called total market index funds.
I'll explain why in a moment. But first, back to September 2003, when a lot of "experts" were already clamoring that the money had been made and the small-cap rally was cooked. I jumped at the bait (and I hope you did, too).
First, I confessed to having loaded up on the iShares S&P SmallCap 600 Index (IJT) the previous January -- at around $65 for a quick 25% gain. Next, I suggested that you could still buy this low-cost small-cap index yourself and still make out. If you did, you're sitting on another 50% gain. Well done.
Why you should keep it small
I won't rehash my entire argument for why I liked small caps then, but a few points are worth touching on. First, we were coming out of a recession, and small-cap growth stocks are notoriously hot during recoveries. Second, we hadn't nearly made up the ground lost during the '90s mega-cap love fest.
And don't sleep on this last point. I catch grief for constantly pointing out how difficult it would be for a massive operation like Dell (NASDAQ:DELL) to double its $50 billion in sales, no matter how much I love the computers (when they're not bursting into flames, that is). But there may be something else.
Even if Dell did double its revenues, the stock could still let you down. In fact, revenues and earnings for giants like Dell and Cisco Systems (NASDAQ:CSCO) have been climbing for years. Yet the stocks have been dogs since we last spoke in September 2003. And that, my friend, is what I call an uncomfortable morning after.
But we're just getting buzzed
Plus, even if I am irrationally exuberant about small caps as a group, it's not the end of the world. In my view, the advantages of small companies extend beyond relative valuations. By definition, small companies are more agile and better poised for massive growth than the behemoths we hold in our "total market" funds.
Which is why I'm a fan of Tom Gardner's Hidden Gems approach. For one thing, he picks stocks from the bottom up. When you focus on specific companies, you don't need to rely on across-the-board strength in a sector or investment style. And if you focus on small caps, you get another bonus -- if you know how to play it.
There's less information out there on smaller, more thinly traded stocks, making the market less efficient. Moreover, as Tom is fond of explaining, the lack of interest in these stocks keeps you out of crowded auction-house bidding wars like the one that broke the bank for large-cap investors in 2000.
Finally, the problem with your mutual funds
Please don't assume you're covered because you own broad market stock funds, even so-called total market funds. In fact, these funds are dominated by large-cap growth stocks. Which means that you're overweight in $350 billion General Electric (NYSE:GE) and $250 billion Microsoft (NASDAQ:MSFT).
Worse, because the index is weighted by market cap, your tail is wagging your dog. How so? Well, toss in $240 billion Citigroup (NYSE:C) and $400 billion ExxonMobil (NYSE:XOM), plus a handful of other giants, and just 10 stocks make up more than 15% of your "total market."
In other words, while you may think you own an equal chunk of 3,756 stocks, you've really got a wedge of No. 1, a chunk of No. 5, and a tiny sliver of No. 3,756 (whatever that is).
That's why a big sell-off in $166 billion AIG (NYSE:AIG) sends you running for the Alka-Seltzer, while the best day in the history of No. 3,756 (whatever that is) barely buys you lunch.
Famous last words
Even if you agree that mega caps are due, you still shouldn't dump your small-cap stocks. History proves that many (if not all) of tomorrow's Goliaths are Davids today. And unlike Exxon or Dell, an extra $1 billion in earnings could propel you into a whole new lifestyle and tax bracket.
If that sounds like some sweet action, you should give Hidden Gems a holler. Tom and his analysts have already turned up a dozen or so stocks that doubled in value or more. And he has me convinced that a 10-bagger or two might be on his buy list already.
If you're looking for small-cap ideas, that's where I'd start. In fact, you can check out all Tom's picks and the full write-ups the instant you start your trial. If you're not impressed by what you see, simply don't subscribe. To have a look, click here.
This article was originally published on March 24, 2006. It has been updated.
Paul Elliott promises to keep you posted on the progress at Hidden Gems. As of Sept. 7, 2006, the picks are up 27%, versus 12% if you'd bought the S&P 500 instead. You can view them all on the Scorecard with your free trial. Paul doesn't own any of the stocks mentioned.Microsoft is an Inside Value pick.Dell has been recommended in both Stock Advisor and Inside Value. The Motley Fool has adisclosure policy.
